Comment on "Evaluating Recipes for Development Success": The Policy Usefulness of Institutional and Political Analyses of Development

In "Evaluating Recipes for Development Success" Avinash Dixitcriticizes recent efforts to identify the "fundamental" causesof development and to distill policy recommendations from theseefforts. This comment focuses on the strand of that literaturerelated to institutions and development. Two arguments are important:that the rule of law and the security of property rights areimportant for growth and that they are the product of politicalinstitutions. Professor Dixit argues that identification andother concerns undermine the second argument and inhibit theformulation of policy recommendations. While these concernsare valid, research has begun to disaggregate broad politicalinstitutions (democracy and autocracy) and to look at the detailsof political competition, such as voter information and politiciancredibility, which are both more robust determinants of politicaldecision-making and more susceptible to policy interventions. JEL codes: O43, O17, O20, P30, P48     

Paths of Institutional Development: A View from Economic History

This article surveys an influential new research program onhistorical paths of institutional development and their consequencesfor growth. The research program exploits the experience ofEuropean colonialism as a kind of "natural experiment" whoseresults bear on the way institutions affect development. Thecentral hypothesis of this research is that societies that beganwith more extreme inequality were more likely to develop institutionsallowing much of the population only limited access to economicopportunities. The research has uncovered a striking reversalof fortune among the areas colonized by Europe; those that wererelatively rich in the 1600s are today far poorer than the areas(such as the United States and Canada) that initially were viewedas relatively undesirable. The timing of the reversal—atthe onset of the Industrial Revolution, when there was probablya premium on broad participation in commercial activity—suggeststhat institutions associated with high inequality may be a causalfactor in low aggregate incomes. This research program is stillin its early stages. But studies of institutions in India usingdata rich enough to permit hypothesis-testing provide evidencesupporting the hypotheses developed in the analysis of the Europeancolonial experience.      

Evaluating Recipes for Development Success

This article offers a provocative critique of the ability ofresearch on the impact of institutions on growth to offer immediateand practical recommendations for reforming and redesigninginstitutions in developing countries and transition economies.The literature traces the sources of growth to unalterable historicaland geographic features. It contains equally plausible recommendationsfor opposite courses of action. It is sometimes driven by fadsor recommends imitation of the latest success story. Some recommendationsare too vague or too general to constitute practical advice.The article suggests a Bayesian diagnostic procedure to identifythe causes of economic failure in an individual country as afirst step toward remedying the failure. JEL codes: O43, O17, O20, P30, P48     

Enforcement and Good Corporate Governance in Developing Countries and Transition Economies

More than regulations, laws on the books, or voluntary codes,enforcement is key to creating an effective business environmentand good corporate governance, at least in developing countriesand transition economies. A framework is presented to help explainenforcement, the impact on corporate governance when rules arenot enforced, and what can be done to improve corporate governancein weak enforcement environments. The limited empirical evidencesuggests that private enforcement tools are often more effectivethan public tools. However, some public enforcement is necessary,and private enforcement mechanisms often require public lawsto function. Private initiatives are often also taken underthe threat of legislation or regulation, although in some countriesbottom-up, private-led initiatives preceded and even shapedpublic laws. Concentrated ownership aligns incentives and encouragesmonitoring, but it weakens other corporate governance mechanismsand can impose significant costs. Various steps can be takento reduce these costs and reinforce other corporate governancemechanisms. But political economy constraints, resulting fromthe intermingling of business and politics, often prevent improvementsin the enforcement environment and the adoption and implementationof public laws.      

Toward Transparency: New Approaches and Their Application to Financial Markets

The Asian financial crisis in the late 1990s not only highlightedthe welfare consequences of transparency in the financial sectorbut also linked this relatively narrow problem to the broadercontext of transparency in governance. It has been observedthat objections to transparency, often on flimsy pretexts, arecommon even in industrialized countries. This article arguesthat transparency is indispensable to the financial sector anddescribes its desirable characteristics: access, timeliness,relevance, and quality. The authors emphasize the need to weighthe costs and benefits of a more transparent regulatory policy,and they explore the connection between information imperfections,macroeconomic policy, and questions of risk. The article arguesfor developing institutional infrastructure, standards, andaccounting practices that promote transparency, implementingincentives for disclosure and establishing regulations to minimizethe perverse incentives generated by safety net arrangements,such as deposit insurance. Because institutional developmentis gradual, the authors contend that relatively simple regulations,such as limits on credit expansion, may be the most reasonableoption for developing countries. They show that transparencyhas absolute limits because of the lack of adequate enforcementand argue that adequate enforcement may be predicated on broaderreforms in the public sector.      

Competition in the Financial Sector: Overview of Competition Policies

Competition in the financial sector, as in other sectors, mattersfor allocative, productive, and dynamic efficiency. Theory suggests,however, that unfettered competition is not necessarily bestgiven the special features of financial services. The authordiscusses these analytical complications before reviewing howto assess competition in the financial sector and its determinants.It is shown that competitiveness varies greatly across countries,in perhaps surprising ways, and that it is not driven by financialsystem concentration. Rather, systems with greater foreign entryand fewer entry and activity restrictions tend to be more competitive,confirming that contestability—the lack of barriers toentry and exit—determines effective competition. The authorthen analyzes how competition policy in the financial sectorhas generally been conducted and how changes in competitionin the financial services industries should affect competitionpolicy going forward. In part based on comparison with otherindustries, the author provides some suggestions on how competitionpolicy in the financial sector could be better approached aswell as what institutional arrangements best fit a modern viewof competition policy in the sector. The specific competitionchallenges for developing countries is also highlighted. Theauthor concludes that practices today fall far short of theneed for better competition policy in the financial sector. JEL codes: G10, G18, G28, L1, L5     

Privatization and Corporate Governance: Principles, Evidence, and Future Challenges

Unless developing countries embrace a corporate governance perspective,privatization is unlikely to provide the benefits of improvedperformance with accountability. This article introduces theconcept of governance chains that can constrain the grabbinghands of public and private actors by providing informationand accountability mechanisms to help investors monitor managers.Empirical data on established firms from 49 countries provideestimates of the relative importance and strength of privateand formal chains of governance. The framework and empiricalbenchmarks help explain the outcomes of past privatizationsand suggest certain steps that governments can pursue to besure to get the most out of future privatization activity.      

Democracy, Public Expenditures, and the Poor: Understanding Political Incentives for Providing Public Services

The incentives of politicians to provide broad public goodsand reduce poverty vary across countries. Even in democracies,politicians often have incentives to divert resources to politicalrents and private transfers that benefit a few citizens at theexpense of many. These distortions can be traced to imperfectionsin political markets that are greater in some countries thanin others. This article reviews the theory and evidence on theimpact on political incentives of incomplete information forvoters, the lack of credibility of political promises, and socialpolarization. The analysis has implications for policy and forreforms to improve public goods provision and reduce poverty.      

Privatization,financial development,property rights and growth

This study analyzes how prevailing institutional arrangements i.e., property rights, contracting rights, political institutions, and corporate governance practices affect privatized firms’ performance, capital markets development, and economic growth. Most of the studies surveyed show that privatization enhances privatized firms performance, efficiency, and profitability, which percolates to economic growth. Privatized firms performed better in countries with better regulatory and legal frameworks. Partial privatization may be beneficial in countries with weak institutions, namely, the French civil law countries. The stronger the economic and the governing institutions, the easier it is for privatized firms to thrive and contribute to economic growth. Overall, privatization allows firms to achieve improved efficiency while driving the development of the financial sector.     

Growth and Institutions: A Review of the Evidence

Africa's disappointing economic performance, the East Asianfinancial crisis, and the weak record of the former Soviet Unionhave focused attention on the role of institutions in determininga economic growth. This article critically reviews the literaturethat tries to link quantitative measures of institutions, suchas civil liberties and property rights, with growth of grossdomestic product across countries and over time. An importantdistinction is made between indicators that measure the performanceor quality of institutions and those that measure politicaland social characteristics and political instability. The evidencesuggests a link between the quality of institutions and investmentand growth, but the evidence is by no means robust.      

Governance Indicators: Where Are We, Where Should We Be Going?

Progress in measuring governance is assessed using a simpleframework that distinguishes between indicators that measureformal rules and indicators that measure the practical applicationor outcomes of these rules. The analysis calls attention tothe strengths and weaknesses of both types of indicators aswell as the complementarities between them. It distinguishesbetween the views of experts and the results of surveys andassesses the merits of aggregate as opposed to individual governanceindicators. Some simple principles are identified to guide theuse and refinement of existing governance indicators and thedevelopment of future indicators. These include transparentlydisclosing and accounting for the margins of error in all indicators,drawing from a diversity of indicators and exploiting complementaritiesamong them, submitting all indicators to rigorous public andacademic scrutiny, and being realistic in expectations of futureindicators. JEL codes: H1, O17     

WHAT DO WE KNOW ABOUT THE POLITICAL ECONOMY OF ECONOMIC POLICY REFORM?

The recent wave of democratization in developing countries andin formerly communist ones has sparked renewed interest in therelation between politics and economic adjustment. Adjustmentprograms, however well designed in a technical economic sense,are often politically difficult to launch and, once launched,to keep afloat. Success in implementing an adjustment programmay depend on a government's skill in generating political supportand holding off the opposition. This article explores the politicsof economic reform, drawing on country studies by politicalscientists and country specialists, the growing theoreticalliterature by economists, and the findings of a World Bank researchproject on the political economy of adjustment in new democracies.The article examines three broad clusters of variables: institutionalcharacteristics of the political system, aspects of the internaland external economy, and the design of the reform program.It also considers the relevance of political analysis for policymakersand for international financial institutions.      

REFORMING FINANCE IN TRANSITIONAL SOCIALIST ECONOMIES

Financial reforms initiated in most transitional socialist economiesdo not yet adequately provide many of the financial servicesassociated with market-oriented financial systems. Such services—mobilizingresources, selecting firms and allocating capital, monitoringfirm managers, and facilitating the management of transactionsand risk—are a necessary condition for economic reformto improve living standards. This article envisages four central strategies to guide reformof the financial sector: • Building an infrastructure based on clear and enforceableproperty rights, modern accounting and auditing standards, reliablepayments systems, sound prudential and enforcement regulations,and professionals trained in finance • Ending the shell game of trying to hide the losses ofstate-owned enterprises, and separating government decisionsto finance "priority" firms from the allocation decisions ofindependent financial institutions • Privatizing some financial institutions early—althoughnot necessarily precipitously—in concert with the privatizationof firms and supervisory capabilities, meanwhile cleaning upbank loans to maximize the chances that firms and banks willsucceed as private entities • Improving the tax system and stressing a prudent interestrate policy to reduce uncertainty, distortions, and excessiverepression of the financial sector.      

Social Investment Funds: An Organizational Approach to Improved Development Assistance

This paper examines the design of social investment funds (SIFs)and explores the ways they affect agents' incentives to propose,select, and implement good projects. Compared with other formsof decentralized service provision, SIFs possess features ofadministratively delegated authority and deep political devolution.Where existing political institutions fail to deliver assistanceto vulnerable groups, a well-designed SIF may represent a usefuladministrative alternative. This article reviews several featuresthat provide incentives for both SIF staff and project beneficiariesand concludes with practical guidelines for designing and appraisingsocial investment funds.      

Why OECD Countries Should Reform Rules of Origin

With preferential trade agreements on the rise worldwide rulesof origin—which are necessary to prevent trade deflection—areattracting increasing attention. At the same time, preferenceerosion for Generalized System of Preferences (GSP) recipientsis increasing resistance to further multilateral negotiations.Drawing on different approaches, this article shows that thecurrent system of rules of origin that is used by the EuropeanUnion and the United States in preferential trade agreements(including the GSP) and that is similar to systems used by otherOrganisation for Economic Co-operation and Development countriesshould be drastically simplified if developed economies reallywant to help developing economies integrate into the world tradingsystem. In addition to diverting resources for administrativetasks, current rules of origin carry significant compliancecosts. More fundamentally, it is becoming increasingly clearthat they are often been designed to force developing economiesto buy inefficient intermediate products from developed economiesto "pay for" preferential access for the final product. Theevidence also suggests that a significant share of the rentsassociated with market access (net of rules of origin compliancecosts) is captured by developed economies. Finally, the restrictivenessof rules of origin is found to be beyond the levels that wouldbe justified to prevent trade deflection, suggesting a captureby special interest groups. The article outlines some alternativepaths to reforms. JEL codes: F13, F15     

Competition and Scope of Activities in Financial Services

This article analyzes the costs and benefits of different degreesof competition and different configurations of permissible activitiesin the financial sector and discusses the related implicationsfor regulation and supervision. Theory and experience demonstratethe importance of competition for efficiency and confirm thata competitive environment requires a contestable system—meaningone that is open to competition—but not necessarily alarge number of institutions. A competitive banking system canimprove the distribution of consumer credit, enhance the corporatesector's access to financing, and mitigate the risks of financialcrises. In an open market, in which services and products areprovided in response to market signals, financial institutionsrespond by offering a wider scope of financial services. Theoptimal institutional design for supervisory functions is lessobvious.      

Addressing Gender-Based Violence: A Critical Review of Interventions

This article highlights the progress in building a knowledgebase on effective ways to increase access to justice for womenwho have experienced gender-based violence, offer quality servicesto survivors, and reduce levels of gender-based violence. Whilerecognizing the limited number of high-quality studies on programeffectiveness, this review of the literature highlights emerginggood practices. Much progress has recently been made in measuringgender-based violence, most notably through a World Health Organizationmulticountry study and Demographic and Health Surveys. Evenso, country coverage is still limited, and much of the informationfrom other data sources cannot be meaningfully compared becauseof differences in how intimate partner violence is measuredand reported. The dearth of high-quality evaluations means thatpolicy recommendations in the short run must be based on emergingevidence in developing economies (process evaluations, qualitativeevaluations, and imperfectly designed impact evaluations) andon more rigorous impact evaluations from developed countries. JEL codes: J16, K42, I18     

Evaluation in the Practice of Development

Standard methods of impact evaluation often leave significantgaps between what we know about development effectiveness andwhat we want to know—gaps that stem from distortions inthe market for knowledge. The author discusses how evaluationsmight better address these knowledge gaps and so be more relevantto the needs of practitioners. It is argued that more attentionneeds to be given to identifying policy-relevant questions (includingthe case for intervention), that a broader approach should betaken to the problems of internal validity (including heterogeneityand spillover effects), and that the problems of external validity(including scaling up) merit more attention by researchers. JEL codes: H43, O22     

CREDIT POLICIES: LESSONS FROM JAPAN AND KOREA

The success of policy-based credit programs in Japan and theRepublic of Korea suggests that credit policy can be an effectiveinstrument for economic development. Why, then, have creditpolicies failed in so many countries, and what factors explaintheir relative success in Japan and Korea? Both economic and institutional factors appear to be importantin the success or failure of credit policies. Essential economicfactors include a reliance on the private sector, a bias towardindustrialization, an orientation toward export production,the encouragement of domestic competition, and a commitmentto price stability. Crucial institutional factors include extensiveand frequent consultation between government and the privatesector, effective monitoring systems, and, most important, aclear and credible plan for economic development. Although severalcountries have included one or more of these factors in theirprograms, the experience of Japan and Korea suggests that acomprehensive network combining all or most of these factorsmay be necessary for the successful implementation of creditpolicies.      

What Should the World Bank Think about the Washington Consensus?

The phrase "Washington Consensus" has become a familiar termin development policy circles in recent years, but it is nowused in several different senses, causing a great deal of confusion.In this article the author distinguishes between his originalmeaning as a summary of the lowest common denominator of policyadvice addressed by the Washington-based institutions (includingthe World Bank) and subsequent use of the term to signify neoliberalor market-fundamentalist policies. He argues that the latterpolicies could not be expected to provide an effective frameworkfor combating poverty but that the original advice is stillbroadly valid. The article discusses alternative ways of addressingthe confusion. It argues that any policy manifesto designedto eliminate poverty needs to go beyond the original versionbut concludes by cautioning that no consensus on a wider agendacurrently exists.