Dispatch #66: How to get to Denmark?

In this dispatch, we continue our discussion on the state strength and significance of institutions. We will take a deeper look at what factors drive the supply and demand for good institutions.

This was the question that Lant Pritchett and Michael Woolcock tried to answer in their 2004 paper titled ‘Solutions when the solution is the problem: Arraying the disarray in development’. By Denmark, the authors didn’t mean the geographical entity rather they used it as a metaphor. Denmark for them is a metaphorical place that has well-functioning state institutions which contribute to economic development. In this dispatch, we will look into the theory of institutions. We will stay away from the debate of whether economic development leads to good institutions or whether is it the other way around. Instead, we will focus on the supply and demand of good institutions. 

In the previous dispatch, we discussed the significance of state strength as one of the key principles of ‘stateness’ and something that drives state effectiveness. The discussion on state strength has always dominated the development policy community. It manifests in terms of institutions. The quality of institutions in a country determines its pathway to economic development. Fukuyama, in his book State Building: Governance and world order in the 21st century examined the relationship between institutions and economic development. He begins his argument with an assertion that in the post-cold war era the intellectual dominance of economists led to solutions such as limited state and liberalisation to address the inefficiency problems. But a few decades later a realisation dawned that ‘some of the most important variables affecting development weren’t economic at all but were concerned with institutions and politics’. The fact that institutions are critical factors for economic development has now become conventional wisdom with extensive research by Robinson and Acemoglu, William Easterly and Van de Walle. 

Now, since we have agreed that institutions are important for development, let’s see what drives the supply of good institutions. Fukuyama argues that 4 factors determine the supply side of institutions:

1. Organisational design and management: This aspect is related to the domain of management studies when applied in the private sector and the domain of public administration when applied in the public sector. There have been efforts to formalise the knowledge of the organisation and public administration and try to give some structure to the theory. However, there isn’t much when it comes to formal theory.

2. Political system design: This aspect refers to the institutional design at the state level. This aspect essentially corresponds to the field of political science. In the pre-World War 2 period, the field of political science focused on the design of political and legal institutions before these institutions were looked at with a sociological lens later on. It was said that the institutions are mostly ‘determined by the economic and social substructure’. The focus of institutions is very new within comparative politics studies. 

Fukuyama weighs in on political institutions:

The same institution can promote or detract from economic growth depending on whether there are complementary institutions that promote its functionality. For example, federalism and decentralization have been widely touted as ways of making government more responsive politically and more supportive of economic growth. But in Russia, poor tax enforcement led to the competition of local governments with the federal government for revenues from the same tax base. Since the local level had better access to information, the result was a collapse of tax revenues during the 1990s at the federal level.

3. Basis of legitimization: The state institutions not only must work together in an administrative sense but they ‘have to be perceived as being legitimate by the society.’ In his 1975 book titled ‘Political order in changing societies,’ Samuel Huntington argued that the two aspects can be separated, that is, the countries could have evolved institutions and hence stateness that could be independent of the legitimisation of those institutions. He would have argued that ‘the former Soviet Union and the United States both were highly politically developed societies, despite the fact that one was a communist dictatorship and the other a liberal democracy’. Fukuyama thinks that it’s not that straightforward to separate institutional capacity and legitimacy. And the most important source of legitimacy, in the 21st century, is democracy.Hence institutional capacity and democracy cannot be separated easily.

Fukuyama adds:

A good state institution is one that transparently and efficiently serves the needs of its clients- the citizens of the state. In areas like monetary policy, the goals of the policy are relatively straightforward (that is price stability) and can be met by relatively detached technocrats. Hence central banks are constructed in ways that deliberately shield them from short-term democratic political pressure. In other sectors like primary and secondary education, the quality of the public agency’s output greatly depends on the feedback received from the ultimate consumers of government services. It is hard to imagine technocrats working in isolation from the people they serve doing a good job in these areas. Hence democracy, apart from its legitimating value, has a functional role in governance as well.

There’s a huge body of literature on the relationship between democracy and development. There are countries where autocratic leadership steered economic reforms and there are democracies that have lifted millions out of poverty. Hence, the relationship between economic development and the legitimacy of institutions (democracy) is complex.

Fukuyama explains:

It is clear that it is not authoritarianism per se that determines economic outcomes but rather the quality of the authoritarian leader and the technocrats advising him or her. Authoritarian countries as a group might do well if they could all be run by Lee Kwan Yew; given that they are as often run by a Mobutu or a Macros, it is not surprising that authoritarian regimes show much greater variance than democratic ones in terms of development outcomes. Democratic regimes at least have some institutional checks against the worst forms of incompetence or rapacity: Bad leaders can be voted out of office.

On legitimacy in authoritarian and democratic countries, Fukuyama further adds:

Authoritarian countries, moreover, have long-term problems with legitimacy. Many have sought to legitimize themselves through their ability to deliver on growth, but when growth ceases or turns into decline (as was the case for Suharto’s Indonesia in 1997-98), legitimacy disappears and instability ensues. Democratic countries are often better able to survive economic setbacks because their legitimacy comes from democracy itself. At the same time, there have been significant examples of democratic countries making hard economic reform choices.

4. Cultural and structural factors: This refers to the norms, values and culture in a country that affects the supply as well as the demand of institutions. Cultural factors significantly determine the development of formal institutions. Fukuyama explains by asking, ‘What happens when Japanese or Korean-style economic planning agencies are transplanted to Brazil or Pakistan?’

The role of culture and societal norms in society has always triggered debates. On cultural factors, Fukuyama adds:

The institutional quality of postwar economic planning agencies in Japan, Korea, and Taiwan did not emerge out of a technocratic how-to manual; it had its roots in a mandarin bureaucratic tradition specific to each country that stretched back for many centuries. The attitudes of the elites running those agencies had a huge impact on their ultimate success; the view that government office presents an opportunity for predatory rent-seeking is one that could have become widespread but did not. The Weberian state had, in other words, historical precedents in Asian societies and was therefore much less susceptible to capture or undermining by neopatrimonialism or clientelism.

Well, the last point is a big exception in the Indian context. Neopatrimonialism and clientelism in India deserve a separate post altogether. 

Now let’s examine if the above-mentioned supply-side variables can be transferred from one country to another.

Source: Fukuyama

The biggest chunk of transferable knowledge lies in the first factor that determines the supply of institutions- public administration and organisational design. Organisations and administrative structures, according to Fukuyama, can be ‘revamped, destroyed, created anew, or managed for better or worse in ways that draw on the historical experience of a wide range of countries’. As long as organisational theory or theory of administration can be formalised, it can be transferred. The second and third factors are moderately transferable since the institutional design and the legitimacy of institutions depend on the design of the political systems. The post-war constitutions of Germany and Japan are prime examples of this kind of transferability. The problem with these two factors is that changing course for a country is very costly, hence path-dependencies reign in. This results in countries rarely reforming their political institutions on a system-wide scale. Reforms are difficult and only a deep-seated crisis can lead to ‘create the political conditions for major institutional reforms.’ The fourth supply side component-social and cultural factors- have a minimal probability of transferability and ‘can be manipulated by public policy only at the margin.’ 

Finally, let’s quickly look at the demand side of institutions. A straightforward economic principle is that incentives motivate behaviour. However, good economic institutions do not always generate their own demand. There could be two reasons for a low demand for good institutions- every new institutional set-up produces winners and losers and society may be unaware of the efficiency or inefficiency of the new institutions. 

Fukuyama adds:

Severe exogenous shock such as currency crisis, recession, hyper-inflation, revolution or war can create demand for institutions.

A similar argument was given by Charles Tilly in his famous book ‘The formation of national states in Western Europe’. He explained that the rise of the modern European state can be attributed to the ‘need to wage war on an even larger scale that drove the demand for tax extraction, administrative capacity and bureaucratic centralisation in states like France, Spain and Sweden.’

Apart from the crisis that led to the demand for institutions, good institutions were created when there was widespread demand within society. The supply of institutions followed the demand. 

Just to sum up key themes from the previous and this post. Governments in developing countries are not able to deliver public services and function effectively because their scope of functions is too large and their strength or quality of institutions is weak. Hence, what is important is that ‘the majority of developing countries is to increase the basic strength of their state institutions to supply those core functions that only governments can provide.’ Therefore, it’s not that the developing countries are not aware of the ‘how’ of ‘getting to Denmark’. They lack the political means to reach that stage since there’s an ‘insufficient local demand for reform’ or institutional building. 

Revisiting the four supply-side factors for good institutions, Fukuyama concludes:

For those countries that do have some prospect of getting at least part way to this promised land, we need to focus much more closely on those dimensions of stateness that can be manipulated and ‘built’. This means concentrating on public administration and institutional design components. We also need to focus particularly on the mechanisms for transforming knowledge about these components to countries with weak institutions.