Weak institutional Structures in Developing Countries

 Economies
cannot function in an institutional vacuum; otherwise there is economic (and
political) chaos. At the very minimum there has to be the rule or law; the
protection of property rights and constraints on power and corruption if
private individuals are to be entrepreneurial, to take risks and invest. 

In
many developing countries, the rule of law and the protection of property
rights is still rudimentary, and politicians (and bureaucrats abuse their
powers. Many economists have recently argued that it is
weak institutional structures that are the fundamental causes of
underdevelopment because the character of institutions is the determinant of
all the proximate causes of progress such as investment, education, trade and
so on.

 Three main ones are highlighted: the extent of
legal protection of private property; the quality if governance (including the
strength of the rule of law) and the limit placed on political leaders.
Attempts have been made to distinguish economically the relative importance of
institutions compared with other factors (including geography) in explaining
different levels of per capita income across the world, with interesting, but
controversial results. 

Rodrick et al (2002) take a large sample of developed and
developing countries, measuring the quality of institutions mainly by a
composite indicator or a number of elements that, capture protection afforded
by property rights, and conclude ‘our results indicate that the quality of
institutions overrides everything else. 

Controlling for institutions, geography
has, at least weak direct effects on income …similarly trade has no direct
positive effect on income,” Easterly and Lavine (2002) also test the
influence of institutions compared with geography and policy variables across
75 rich and poor countries and find that institutions seem to matter most as
the determinant of per capita income. Even countries with ‘bad policies’ do
well with good institutions.

Defining
and Measuring Institutions

What
do we mean by institutions?

The
term institution has been defined in different ways. Douglass North (1990)
describes institutions very broadly, as the formal and informal rules governing
human interactions. There are also narrow (and easier to grasp) definitions of
institutions that focus on specific organizational entities, procedural devices
and regulatory framework. 

At a more intermediate level, institutions are
defined in terms of the degree of property rights protection, the degree to
which laws and regulations are fairly applied, and the extent of corruption. It
is narrower than North’s definition, which includes all of the norms governing
human interactions. Much of the recent research into determinants of economic
development has adopted the intermediate definition.

How
is institutional quality measured?

Recent
empirical analyses have typically considered three relatively broad measures of
institutions — the quality of governance, including the degree of corruption,
political rights, public sector efficiency, and regulatory burdens; the extent
of legal protection of private property and how well such laws are enforced;
and the limits placed on political leaders. The measures themselves are not
objective but, rather, the subjective perceptions and assessment of country
experts or the assessment; made by residents responding to surveys carried out
by international organizations and non-governmental organizations.

The
first of these measures — the aggregate governance index — is the average of
the six measures of institutions developed in a 1999 study by Daniel Kaufman,
Art Kraay and Pablo Zoido-Lobaton. These measures include 

(1) voice and
accountability the extent to which citizens can choose their government and
have political rights, civil liberties and an independence press; 

(2) political
stability and absence of violence – the likelihood that the government will not
be overthrown by unconstitutional or violent means 

(3) government effectiveness
– the quality of public service delivery and competence and political
independence of the civil service 

(4) regulatory burden – the relative absence
of government controls on goods markets, banking systems, and international
trade; 

(5) rule of law – the protection of persons and’ property against
violence and theft, independence and effective judges, and contract enforcement;
and 

(6) freedom from graft – public power is not abused for private gain or
corruption.

A
second measure focuses on property rights. This measure indicates the
protection that private property receives. Yet another measure, constraints on
the executive, reflects institutional and other limits placed on presidents and
other political leaders. In a society with appropriate constraints on elites
and politicians, there is less fighting between various groups for control of
the state, and policies are more sustainable.

It
is recognized, however, that the correlation found between institutions and
economic development could reflect reverse causality, or omitted factors. We
need to find a source of exogenous variation in institutions where institutions
differ or change independently of other factors. 

Acemoglu et el (2001) argue
that the different experience of colonization is one exogenous source where at
one extreme colonizers set up exclusively extractive institutions (to exploit
minerals and other primary products) such as slavery and forced labour – which
neither gave property rights to inhabitants nor constraints the power of
elites. 

This was the experience in Africa and Latin America, At the other extreme,
colonizers created settler societies, replicating the European form of
institutions protecting private property and controlling elites and politicians
in countries such as Australia, New Zealand and North America. But what
determines why some countries were settled and others not? Acemoglu et al
argued that the major determinant was the mortality rate faced by the early
settlers, and that there is both a negative correlation between past mortality
rates and current institutional quality (because institutions persisted) and
between past mortality and the current levels of per capita income. 

In fact,
over 50 per cent of the variations In per capita income across the 75 countries
is associated with variation in one particular index of institutional quality which measures ‘protection
against expropriation.’ The authors conclude ‘There is 3 high correlation
between mortality rates faced by soldiers, bishops and sailors in the colonies
and European settlements; between European settlements and early measures of
institutions, and between early institutions and institutions today. 

We
estimate large effects of institutions on income per capita using this source
of variation.’ They say that this relationship is not driven by outliers, and
is robust controlling for latitude, climate, current disease environment,
religion, natural resources, soil quality, ethyl° linguistic fragmentation, and
current racial composition’. But this is where the controversy starts because
presumably his mortality rates of the early settlers, which affected the nature
of institutions, was strongly influenced by geography as it affects disease. in
the same vein Sachs (2003) argues that the findings of Acemoglu et al. 

Concerning the negative relation between mortality rates 200 years ago and per
capita income today is simply licking up the pernicious effects of malaria
(which stir persists), not institutions. Development is not simply about good
government and institutions. institutions might make anti-poverty policies more
effective, but that is all. 

Poor countries need resources to fight disease; to
provide education and infrastructure, and all the other resource prerequisites
of development. Sachs classified three types of countries combining
institutions and geography, which is a sensible approach:

·     
Countries where
institutions, policies and geography are all reasonably favourable, e.g. the
coastal regions of East Asia

·     
Countries with favourable
geography, but weak institutions, e.g. many of the transition economies of
Eastern Europe and the former Soviet Union

Countries
impoverished by a combination of unfavourable geography — such as landlocked
countries and those plagued with disease — and poor governance, e.g. many of
the countries of sub-Saharan Africa.