Fri, May 23, 2008 - Page 9 News List

Good governance is about the reform of institutions

By Dani Rodrik

Economists used to tell governments to fix their policies. Now they tell them to fix their institutions. Their new reform agenda covers a long list of objectives, including reducing corruption, improving the rule of law, increasing the accountability and effectiveness of public institutions and enhancing the access and voice of citizens.

Real and sustainable change is supposedly possible only by transforming the “rules of the game” — the manner in which governments operate and relate to the private sector.

Good governance is, of course, essential insofar as it provides households with greater clarity and investors with greater assurance that they can secure a return on their efforts. Placing emphasis on governance also has the apparent virtue of helping to shift the focus of reform toward inherently desirable objectives.

Traditional recommendations like free trade, competitive exchange rates and sound fiscal policy are worthwhile only to the extent that they achieve other desirable objectives, such as faster economic growth, lower poverty and improved equity.

By contrast, the intrinsic importance of the rule of law, transparency, voice, accountability or effective government is obvious. We might even say that good governance is development itself.

Unfortunately, much of the discussion surrounding governance reforms fails to make a distinction between governance as an end and as a means. The result is muddled thinking and inappropriate strategies for reform.

Economists and aid agencies would be more useful if they turned their attention to what one might call “governance writ small.” This requires moving away from the broad governance agenda and focusing on reforms of specific institutions in order to target binding constraints on growth.

Poor countries suffer from a multitude of growth constraints and effective reforms address the most binding among them. Poor governance may, in general, be the binding constraint in Zimbabwe and a few other countries, but it was not in China, Vietnam or Cambodia — countries that are growing rapidly despite poor governance — and it most surely is not in Ethiopia, South Africa, El Salvador, Mexico or Brazil.

As a rule, broad governance reform is neither necessary nor sufficient for growth. It is not necessary, because what really works in practice is removing successive binding constraints, whether they are supply incentives in agriculture, infrastructure bottlenecks or high credit costs. It is not sufficient, because sustaining the fruits of governance reform without accompanying growth is difficult. As desirable as the rule of law and similar reforms may be in the long run and for development in general, they rarely deserve priority as part of a growth strategy.

Governance writ small focuses instead on those institutional arrangements that can best relax the constraints on growth.

Suppose, for example, that we identify macroeconomic instability as the binding constraint in a particular economy. In a previous era, an economic adviser might have recommended specific fiscal and monetary policies — a reduction in fiscal expenditures or a ceiling on credit — geared at restoring macroeconomic balances.

Today, that adviser would supplement these recommendations with others that are much more institutional in nature and fundamentally about governance. So he or she might advocate making the central bank independent in order to reduce political meddling, and changing the framework for managing fiscal policy — setting up fiscal rules, for example, or allowing only an up-or-down legislative vote on budget proposals.

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