EC205 Development Economics (Macro)

For most developing countries, poor infrastructure, education, health and political instability are
some of the reasons cited for a lack of sustained economic growth and prosperity. Thus, the poor performance of developing countries today is commonly blamed by the absence of those governments implementing efficient socio-economic policies with support from effective institutions. Broad ranges of literature have strived to show how different forms of government can lead to various inefficiencies in the institutions that they create and the policies they adopt. Empirical studies have given mixed verdicts; Przeworski and Limongi (1993) published a survey of this literature and even they were unable to rest this argument. Neo-liberals would advocate that a democratic government would facilitate the growth of its economy; but despite having a synergetic relationship, the influence of the type of political regime on a countrys economic growth and vice versa is much more complex. Democracy assists economic development by ensuring private property rights are preserved and markets are made freer. Property rights are cited as an important prerequisite for economic growth because it is property rights that fuel the incentives to produce and consequently exchange that property in order to extract an economic profit. This way, property rights help define individual incentives and also provide the individual with some degree of security. Ultimately, they help to stabilize individual expectations about the behaviour of others and if explicitly defined and enforced, they considerably reduce transaction costs (Leblang, 1996). A market environment requires property rights; however, there is a fundamental tension between democracy and market forces. Whilst democracies may have policies that use de-privatisation and increased taxation which discourage investment, a democratic government can organise the national budget in a more purposeful and efficient way for example, direct funds from the defence ministry to the educational sector or to help small and medium enterprise. Additionally, by creating a welfare state, a democracy can increase labour productivity. Chang (2009) says that if this is implemented together with a good retraining programme, the costs of unemployment will be lower to workers and they will be less resistant to the increases in automation processes that raise productivity. Empirical findings published in Leblangs paper, (1996) evidenced that those countries that protected property rights grew faster than those countries which did not. He also interestingly pointed out that the type of political regime governing a country indirectly has a bearing on economic growth through their commitment to secure property rights. (Banerji and Ghanem, 1997) showed that authoritarian governments are more likely to impose trade protection policies and these are also related with more labour market distortions. The pattern, observed in many authoritarian-led countries in Sub-Saharan Africa, the Middle East, and Latin America in the 1970s and 1980s, through tariffs and quotas helped workers and protected producers who were part of certain industries supported by the regime. Labour was often repressed in other sectors and trade unions seeking more influence were not tolerated. Landell-Mills and Serageldin (1992) cite freedom of association as one of the important elements of good governance which are necessary for development. The study by Banerji and Ghanem hence shows that labour repression is

EC205 Development Economics (Macro) not desirable for development1. Authoritarian regimes which implement repressive labour market policies may stifle economic growth by corrupting the process of production and capital accumulation. If a dictator is faced with a short tenure, Olson (1993) says they would seek to confiscate the property of his subjects, annul any contracts signed in borrowing money from them, and generally ignore the long-run economic consequences of their choices. This reduces confidence in investments and in the enforcement of long-run contracts. A gulf exists in the degree of freedom offered by democratic and authoritarian governments. Freedom in any nation is widely regarded as a positive attribute and is encouraged since it is central to the functioning of a democracy. This sometimes, leads to assumptions that democratic economies will always achieve stronger growth. In reality however, comparatively authoritarian governments such as Singapore, Vietnam, China, Indonesia, Korea, Taiwan, Japan and even the Soviet Union (before World War II) have all experienced periods of rapid economic growth. Whether or not this growth has been equitable for all citizens in the country will differ but much of this growth occurred much faster than the welfare maximising optimal rate (Economist, 2010a). Similarly, we are constantly reminded that authoritarian governments are also responsible for a number of economic and even humanitarian crises experienced in their nations (Zimbabwe and Libya, for example). That said, non-OECD democracies too have their share of unfavourable growth outcomes (Economist, 2010b). It is difficult to assert which type of government has been more successful in supporting positive economic growth in their economy. Partly because there is very little data available for adequate analysis of these governments in their strictest forms; data on authoritarian regimes is not easily obtainable and even democracy itself as a successful political institution is a relatively recent phenomenon2. It would not be accurate to settle on any conclusion on this argument because by the time these democracies such as the USA and those in Europe had effected sufficiently democratic policies, their nations were already developed. Hence, it can be said that not many countries have achieved development as a real democracy and that democratic institutions are in fact a by product (or complement) of economic prosperity. The intuition behind this assertion is that the best functioning democracies require citizens that are rational and well-educated, so poor countries will ultimately struggle to practice suitable democracy because their socio-economic needs are radically different and therefore they are not as rational or well-educated. This turns the argument of whether or not democracies grow faster than authoritarian regimes on its head and instead challenges the possibility that continued economic growth leads to countries implementing more

Studies by Ozler and Rodrik (1992), Barro (1991) too pointed to the fact that the support of civil liberties and strong economic growth are closely and positively correlated showing that the case for a freer market is well supported. 2 For instance, only since the Civil Rights Movement of the 1950s and 1960s has the USA allowed all their citizens the right to vote in general elections.

EC205 Development Economics (Macro) democratic forms of governance in the long run. Authors such as Bilson (1982)3 and Pennar et al. (1993)4 support this view. So as with Przeworski & Limongi (1993), Sirowy & Inkeles (1990) both do not provide any clear conclusion on which form of government engenders higher growth5. This suggests to us that it is reasonable to work on the assumption that democratic institutions are compatible with effective economic development. There are various ways in which democracies can be more prone to inefficiencies in their policies and institutions leading to instances of corruption. Shleifer & Vishny (1993) proposed that the structures of governments institutions as well as their political processes are important determinants of the level of corruption. This is especially true because governments that do not control their agencies lead to an increased possibility of corrupt practices. Corruption, as noted by Warren (2004), breaks the link between collective decision making and peoples powers to influence collective decisions through speaking and voting, the very link that defines democracy. As government officials place a price on public goods and routine government transactions, the rights which citizens are normally entitled to turns into favours that have to be repaid. Corruption undermines the culture of democracy and public officials soon suffer from a tarnished reputation from the public whether or not they are corrupt. Democracies in some developing countries are particularly prone to corruption as the ruling elites enjoy disproportionate control and influence over democratic institutions, in particular the electoral system. They have privileged access to the instruments of political influence education, literacy, campaign finance (Acemoglu & Robinson, 2006). As a result, they have the power to oppose political strategies through the threat of capital strike and since they are compact groups, their collective action problems are more easily handled than those of numerous groups. Citizens are thus limited in their ability to get the policies that they want because the elites may have power out of proportion to their numbers. The laws and regulations that are part of a democracy cause inefficiencies in a number of daily functions. Consequently, agents resort to corruption to circumvent certain barriers that impede their goals. For example, a mining company looking to set up a factory requires a number of permits and checks to be approved by a city council before commencing business in a new city. It is possible that a bribe is paid to an official in the council office so that the process of obtaining these permits and approvals is made easier. In this instance, Anechiarico & Jacobs (1996) argue that a little bit of corruption that comes with democracies makes them work better by lowering transaction costs, reducing the inefficiencies of cumbersome rules, and generally making things happen. As has been mentioned earlier democracies encourage civil liberties. One of the ways corruption is prevented is democracies is through the freedom of the press. A government-controlled press would be more restricted in the information it provides to the public. In this situation, a free press would

Argued that economic development allows the dynamic elements in the society to achieve status and income independently of the government, thus promoting political freedom. 4 Suggests that growth leads to democracy because of the impact of relative deprivation and the eventual impact of education on a populace that demands political and civil rights. (Heo & Tan, 2001). 5 Due to the difficulty in effectively carrying out statistical tests of these causal hypotheses.

EC205 Development Economics (Macro)

inform voters about various issues including government and public sector misbehaviour, which obviously includes corruption (Svensson, 2005; Besley and Burgess, 2001). Market-orientated economic policies in democracies create an environment for healthy competition between private sector firms. Corruption alters the dynamics of private competition in a number ways so democracies that can deregulate their markets in such a way that removes certain barriers to entry, opportunities for corruption is likely to decrease. The removal of bureaucratic powers gives officials less power to demand and collect bribes. (Svensson, 2005; De Soto, 1989; Shleifer & Vishny, 1993) Reducing corruption increases confidence and dispels the air of under-handedness in any community. While this depends on locals perception of corruption. We have also seen that corruption is negatively related to the productivity of human capital if and when the right balance can be achieved between checks and measures that are necessary enough to not stifle optimum performance. But again, whatever system is implemented, constant revision is required and each situation has to be dealt with in its context with all variables considered. An interesting way in which local-level corruption was minimised in Ugandas education sector is outlined in a study by (Reinikka & Svensson, 2004). Where only a small amount of funds allocated by the central government were received by primary schools, the government started publishing newspaper accounts of monthly transfers of grants to each district so that school staff and parents could monitor officials. An important result of this move was a drastic reduction in the amount of funds lost to corruption. The parents and head-teachers were the losers from the corrupt practices; they had a vital information gap narrowed and this resulted in corrupt officials had taken advantage of this. While narrowing this gap is effective in this situation, it is often the case that in another local setting other issues will have to be accounted for. For example, the level of funding available to set up a system of checks will vary from place to place and depending on the importance of the project being carried out. If a government is already prone to corruption and has a culture whereby corrupt practices are prevalent, then implementing adequate measures will much more difficult. Mungiu-Pippidi (2006)suggests that the existence of political particularism is a major barrier for anticorruption initiatives. She points out that many new democracies or countries with weak democratic enforcement are mired by political system creates incentives for politicians to respond to particularistic interests, rather than broad-based interests. Mungui-Pippidi outlines a 3 step strategy to exiting the vicious cycle of particularism. Part of the strategy involves organising those who stand to lose most from corruption, against the status groups and predatory elites and if a political party can be mobilised as part of this group, it will create incentives for other parties to compete and prove who is cleaner. She concludes that corrupt countries cannot always simply replicate the institutions of clean countries, especially when particularism is so prevalent. Ultimately, when looking to minimise local-level corruption, within a government project for example, checks and processes will be limited to what the situation requires; the level of funding available, the number of potential principal actors of corruption are all important considerations for creating adequate anti-corruption systems. In this sense, laws against corruption are not solely sufficient and require anticorruption initiatives. Initiatives include processes whereby those 4

EC205 Development Economics (Macro)

implicated are not incentivised to engage in corrupt practices in the future. Fighting corruption in developing countries may seem like a lost cause and in such societies the fight against particularism is an intrinsic part of the greater modernisation and democratisation process. As Mungui-Pippidi said in her evaluation of her anticorruption campaign6 - It may at times look like civil war, but as the history of democracy shows, civil wars are sometimes needed to advance the cause of accountable government.

Mungui-Pippidi heads the Coalition for a Clean Parliament, which led an anticorruption campaign during Romanias 2004 elections.

EC205 Development Economics (Macro)

References
Anechiarico, F, & Jacobs, J.B., 1996. The Pursuit of Absolute Integrity: How Corruption Control Makes Government Ineffective. Chicago: University of Chicago Press. Banerji, A. & Ghanem, H.. (1997). Does the Type of Political Regime Matter for Trade and Labor Market Policies?. The World Bank Economic Review. 11 (1), pp. 171-194. Besley, T & Burgess, R.,. 2002. The Political Economy of Government Responsiveness:Theory and Evidence From India. Quarterly Journal of Economics. 117:4, pp. 1415-1451. Bilson, J. F. 0., (1982), "Civil Liberty: An Econometric Investigation," Kyklos, 35,pp 94-114. Chang, H., 2009. Bad Samaritans: the myth of free trade and the secret history of capitalism. New York: Bloomsbury Press De Soto, Hernando. 1989. The Other Path. New York: Harper and Row Economics by Invitation, The Economist. (2010a). Guest Debate. Available: http://www.economist.com/economics/byinvitation/questions/are_authoritarian_governments_im pediment_growth [Date accessed: 22.03.2011] Economics by Invitation, The Economist. (2010b). Guest Debate. Available: http://www.economist.com/economics/by-invitation/guestcontributions/no_their_performance_more_variable[Date accessed: 22.03.2011] Gaviria, Ugo Panizza, Seddon, Stein. 2000. Political Institutions and Growth Collapses. InterAmerican Development Bank : Working Paper Number 419. Heo, U. & Tan, A.C., 2001, Democracy and economic Growth: A Causal Analysis, Comparative Politics, Vol. 33, No. 4, pp. 463 -473. Huntington, Political Order in Changing Societies; Huntington and Dominguez, 'Political Development', p. 60. Leblang, D. A, (1996). Rights, Democracy and Economic Growth. Political Research Quarterly. 49 (1), pp. 5-26. Landell-Mills, Pierre, and Ismail Serageldin. 1992. "Governance and the External Fac-tor." In Lawrence Summers and Shekhar Shah, eds., Proceedings of the World Bank Annual Conference on Development Economics 1991. Washington, D.C.: World Bank. Mungiu-Pippidi, 2006, CORRUPTION: DIAGNOSIS AND TREATMENT , Journal of Democracy Volume 17, Number 3 , pp. 86-99 North, D., Institutions, Institutional Change, and Economic Performance: Cambridge

EC205 Development Economics (Macro)

Olson, M., 1982, The Rise and Decline of Nations: Economic Growth, Stagflation, and Social Rigidities (New Haven, Conn.: Yale University Press, p. 77. Olson, M. 1993. Dictatorship, Democracy, and Development. American Political Science Review. Vol. 87. No. 3 (September 1993), pp. 567-576 Pennar, K., Smith, G., Brady, R., Lindorff D., and Rossant, J., "Is Democracy Bad for Growth?," Business Week, June 7, 1993. Przeworski, A and Limongi, F.. 1993. "Political Regimes and Economic Growth." Journal of Economic Perspectives 7(summer):51-69. Reinikka, R., and Svensson, J., 2004b. The Power of Information: Evidence from a Newspaper Campaign to Reduce Capture. Manuscript, IIES, Stockholm University. Sindzingre, A., (2005). Reforms, Structure or Institutions? Assessing the Determinants of Growth in Low-Income Countries. Third World Quarterly. 26 (2), pp. 281-305. Sirowy & Inkeles, A.,1990. The Effects of Democracy on Economic Growth and Inequality: A Review. Comparative International Development 25 (1):126-157. Svensson, J. 2005. "Eight Questions about Corruption." Journal of Economic Perspectives, 19(3): 19 42 Warren, M. E., (2004) What Does Corruption Mean in a Democracy?, American Journal of Political Science , Vol. 48, No. 2, pp. 328-343