KAKASHEV: INSTITUTIONS FOR HIGH-QUALITY GROWTH:WHAT THEY ARE AND HOW TO ACQUIRE THEM

ABSTRACT

This paper opens with a discussion of the types of institutions that allow markets to perform

adequately. While we can identify in broad terms what these are, there is no unique mapping between

markets and the non-market institutions that underpin them. The paper emphasizes the importance

of "local knowledge," and argues that a strategy of institution building must not over-emphasize bestpractice

"blueprints" at the expense of experimentation. Participatory political systems are the most

effective ones for processing and aggregating local knowledge. Democracy is a meta-institution for

building good institutions. A range of evidence indicates that participatory democracies enable

higher-quality growth.

Dani Rodrik

John F. Kennedy School of Government

Harvard University

79 JFK Street

Cambridge, MA 02139

and NBER

(617) 495 9454

fax: (617) 496 5747

dani_rodrik@harvard.edu

INSTITUTIONS FOR HIGH-QUALITY GROWTH:

WHAT THEY ARE AND HOW TO ACQUIRE THEM

Sakenn pe prie dan sa fason

(Everyone can pray as he likes.)

-- Mauritian folk wisdom

I. Introduction

The comparative experience with economic growth over the last few decades has taught

us a number of important lessons. One of the more important of these is the importance of

private initiative and incentives. All instances of successful development are ultimately the

collective result of individual decisions by entrepreneurs to invest in risky new ventures and try

out new things. The good news here is that we have found

homo economicus to be alive and

well in the tropics and other poor lands. The idea of "elasticity pessimism"--the notion that the

private sectors in developing countries would fail to respond quickly to favorable price and other

incentives--has been put to rest by the accumulating evidence. We find time and again that

investment decisions, agricultural production, or exports turn out to be quite sensitive to price

incentives, as long as these are perceived to have some predictability.

The discovery that relative prices matter a lot, and that therefore neo-classical economic

analysis has much to contribute to development policy, led for a while to what was perhaps an

excessive focus on relative prices. Price reforms--in external trade, in product and labor markets,

in finance, and in taxation--were the rallying cry of the reformers of the 1980s, along with

macroeconomic stability and privatization. By the 1990s, the shortcomings of the focus on price

reform were increasingly evident. The encounter between neo-classical economics and

Taken from Miles (1999).

developing societies served to reveal the institutional underpinnings of market economies. A

clearly delineated system of property rights, a regulatory apparatus curbing the worst forms of

fraud, anti-competitive behavior, and moral hazard, a moderately cohesive society exhibiting

trust and social cooperation, social and political institutions that mitigate risk and manage social

conflicts, the rule of law and clean government--these are social arrangements that economists

usually take for granted, but which are conspicuous by their absence in poor countries.

Hence it became clear that incentives would not work or generate perverse results in the

absence of adequate institutions. Some of the implications of this were recognized early on, for

example in discussions on rent seeking in the trade policy context (where corruption was the

main issue) or in the discussions on common-property resources (where lack of adequately

defined property rights was the problem). But the broader point that markets need to be

supported by non-market institutions in order to perform well took a while to sink in. Three sets

of disparate developments conspired to put institutions squarely on the agenda of reformers. One

of these was the dismal failure in Russia of price reform and privatization in the absence of a

supportive legal, regulatory, and political apparatus. A second is the lingering dissatisfaction

with market-oriented reforms in Latin America and the growing realization that these reforms

have paid too little attention to mechanisms of social insurance and to safety nets. The third and

most recent is the Asian financial crisis which has shown that allowing financial liberalization to

run ahead of financial regulation is an invitation to disaster.

The question before policy makers therefore is no longer "do institutions matter?"

2 but

"which institutions matter and how does one acquire them?" Following Lin and Nugent (1995,

See Lin and Nugent (1995) for an excellent review of the huge literature on institutions as it relates to economic

development specifically. This literature has been enriched recently by a growing body of empirical cross-national

work that quantifies the growth-promoting effects of superior institutions. See Hall and Jones (1999) on "social

2306-2307), it is useful to think of institutions broadly as "a set of humanly devised behavioral

rules that govern and shape the interactions of human beings, in part by helping them to form

expectations of what other people will do." I begin this paper with a discussion of the types of

institutions that allow markets to perform adequately. While we can identify in broad terms what

these are, I shall argue that there is no unique mapping between markets and the non-market

institutions that underpin them. The plausible variation in institutional setups is larger than is

usually presupposed.

I then turn to the more difficult question of how one thinks about appropriate strategies

for institution building. I emphasize the importance of "local knowledge," and argue that a

strategy of institution building must not over-emphasize best-practice "blueprints" at the expense

of local experimentation. I make the case that participatory and decentralized political systems

are the most effective ones we have for processing and aggregating local knowledge. We can

think of democracy as a meta-institution for building good institutions.

The penultimate section of the paper provides a range of evidence indicating that

participatory democracies enable higher-quality growth: they allow greater predictability and

stability, are more resilient to shocks, and deliver superior distributional outcomes. The

concluding section offers some implications for the design of conditionality.

II. Which Institutions Matter?

infrastructure," Knack and Keefer (1995, 1996) on bureaucratic quality and social capital; Temple and Johnson

(1998) on "social capability"; Rodrik (forthcoming) on institutions of conflict management. Recent work by

Haufmann, Kraay, and Zoido-Lobaton (1999) has developed aggregate indicators of six different aspects of

governance--voice and accountability, political instability and violence, government effectiveness, regulatory

burden, rule of law, and graft--showing that all of these are significantly associated with income levels in the

expected manner.

I refer the reader to Unger (1998) for a broader discussion of this point and of its implications. I have benefited

greatly from talking with Roberto Unger on some of these issues.

Institutions do not figure prominently in the training of economists. The standard Arrow-

Debreu model with a full set of complete and contingent markets extending indefinitely into the

future seems to require no assistance from non-market institutions. But of course this is quite

misleading even in the context of that model. The standard model assumes a well-defined set of

property rights. It also assumes that contracts are signed with no fear that they will be revoked

when it suits one of the parties. So in the background there exists institutions that establish and

protect property rights and enforce contracts. We must, in other words, have a system of laws

and courts to make even "perfect" markets function.

Laws in turn have to written and they have to be backed up by the use of sanctioned

force. That implies a legislator and a police force. The legislator's authority may derive from

religion, family lineage, or access to superior violence, but in each case she needs to ensure that

she provides her subjects with the right mix of "ideology" (a belief system) and threat of violence

to forestall rebellion from below. Or the authority may derive from the legitimacy provided by

popular support, in which case she needs to be responsive to her constituency's (voters') needs.

In either case, we have the beginnings of a governmental structure that goes well beyond the

narrow needs of the market.

One implication of all this is that the market economy is necessarily "embedded" in a set

of non-market institutions. Another is that not all of these institutions are there to serve the

needs of the market economy first and foremost, even if their presence is required by the internal

logic of private property and contract enforcement. The fact that a governance structure is

needed to ensure that markets can do their work does not imply that the governance structure

serves only that end. Non-market institutions will sometimes produce outcomes that are socially

undesirable, such as the use of public office for private gain. They may also produce outcomes

that restrict the free play of market forces in pursuit of a larger goal, such as social stability and

cohesiveness.

The rest of this section discusses five types of market-supporting institutions: property

rights; regulatory institutions; institutions for macroeconomic stabilization; institutions for social

insurance; and institutions of conflict management.

(a) Property rights

While it is possible to envisage a thriving socialist market economy in theory, as the

famous debates of the 1920s established, today's prosperous economies have all been built on the

basis of private property. As North and Thomas (1973) and North and Weingast (1989), among

many others have argued, the establishment of secure and stable property rights have been a key

element in the rise of the West and the onset of modern economic growth. It stands to reason

that an entrepreneur would not have the incentive to accumulate and innovate unless s/he has

adequate control over the return to the assets that are thereby produced or improved.

Note that the key word is "control" rather than "ownership." Formal property rights do

not count for much if they do not confer control rights. By the same token, sufficiently strong

control rights may do the trick even in the absence of formal property rights. Russia today

represents a case where shareholders have property rights but often lack effective control over

enterprises. Town and village enterprises (TVEs) in China are an example where control rights

have spurred entrepreneurial activity despite the absence of clearly defined property rights. As

these instances illustrate, establishing "property rights" is rarely a matter of just passing a piece

of legislation. Legislation in itself is neither necessary nor sufficient for the provision of the

secure control rights. In practice, control rights are upheld by a combination of legislation,

private enforcement, and custom and tradition. They may be distributed more narrowly or more

diffusely than property rights. Stakeholders can matter as much as shareholders.

Moreover, property rights are rarely absolute, even when set formally in the law. The

right to keep my neighbor out of my orchard does not normally extend to my right to shooting

him if he actually enters it. Other laws or norms--such as those against murder--may trump

property rights. Each society decides for itself the scope of allowable property rights and the

acceptable restrictions on their exercise. Intellectual property rights are protected assiduously in

the United States and most advanced societies, but not in many developing countries. On the

other hand, zoning and environmental legislation restricts the ability of households and

enterprises in the rich countries to do as they please with their "property" to a much greater

extent than is the case in developing countries. All societies recognize that private property

rights can be curbed if doing so serves a greater public purpose. It is the definition of what

constitutes "greater public purpose" that varies.

(b) Regulatory institutions

Markets fail when participants engage in fraudulent or anti-competitive behavior. They

fail when transaction costs prevent the internalizing of technological and other non-pecuniary

externalities. And they fail when incomplete information results in moral hazard and adverse

selection. Economists recognize these failures and have developed the analytical tools required

to think systematically about their consequences and possible remedies. Theories of the second

best, imperfect competition, agency, mechanism design, and many others offer an almost

embarrassing choice of regulatory instruments to counter market failures. Theories of political

economy and public choice offer cautions against unqualified reliance on these instruments.

In practice, every successful market economy is overseen by a panoply of regulatory

institutions, regulating conduct in goods, services, labor, asset, and financial markets. A few

acronyms form the U.S. will suffice to give a sense of the range of institutions involved: FTC,

FDIC, FCC, FAA, OSHA, SEC, EPA, and so on. In fact, the freer are the markets, the greater is

the burden on the regulatory institutions. It is not a coincidence that the United States has the

world's freest markets as well its toughest anti-trust enforcement. It is hard to envisage in any

country other than the United States a hugely successful high-tech company like Microsoft being

dragged through the courts for alleged anti-competitive practices. The lesson that market

freedom requires regulatory vigilance has been driven home recently by the experience in East

Asia. In South Korea and Thailand, as in so many other developing countries, financial

liberalization and capital-account opening led to financial crisis precisely because of inadequate

prudential regulation and supervision.

It is important to recognize that regulatory institutions may need to extend beyond the

standard list covering anti-trust, financial supervision, securities regulation and a few others.

This is true especially in developing countries where market failures may be more pervasive and

the requisite market regulations more extensive. Recent models of coordination failure and

capital market imperfections

5 make it clear that strategic government interventions may often be

required to get out of low-level traps and elicit desirable private investment responses. The

experience of South Korea and Taiwan in the 1960s and 1970s can be interpreted in that light.

The extensive subsidization and government-led coordination of private investment in these two

See also the recent paper by Johnson and Shleifer (1999) that attributes the more impressive development of equity

markets in Poland compared to the Czech Republic to the stronger regulations in the former country upholding

minority shareholder rights and guarding against fraud.

See Stiglitz and Hoff (1999) for a useful survey and discussion.

economies played a crucial role in setting the stage for self-sustaining growth (Rodrik 1995). It

is clear that many other countries have tried and failed to replicate these institutional

arrangements. And even South Korea may have taken a good thing too far by maintaining the

cozy institutional linkages between the government and

chaebols well into the 1990s, at which

point these may have become dysfunctional. Once again, the lesson is that desirable institutional

arrangements vary, and that they vary not only across countries but also within countries over

time.

Since Keynes, we have come to a better understanding of the reality that capitalist

economies are not necessarily self-stabilizing. Keynes and his followers worried about shortfalls

in aggregate demand and the resulting unemployment. More recent views of macroeconomic

instability stress the inherent instability of financial markets and its transmission to the real

economy. All advanced economies have come to acquire fiscal and monetary institutions that

perform stabilizing functions, having learned the hard way about the consequences of not having

them. Probably most important among these institutions is a lender of last resort--typically the

central bank--which guards against self-fulfilling banking crises.

There is a strong current within macroeconomics thought, represented in its theoretically

most sophisticated version by the real business cycles (RBC) approach--that disputes the

possibility or effectiveness of stabilizing the macroeconomy through monetary and fiscal

policies. There is also a sense in policy circles, particularly in Latin America, that fiscal and

monetary institutions--as currently configured--have added to macroeconomic instability, rather

than reduced it, by following pro-cyclical rather than anti-cyclical policies (Hausmann and Gavin

1996). These developments have spurred the trend towards central bank independence, and

helped open a new debate on designing more robust fiscal institutions.

Some countries (Argentina being the most significant example) have given up on a

domestic lender of last resort altogether by replacing their central bank with a currency board.

The Argentine calculation is that having a central bank that can occasionally stabilize the

economy is not worth running the risk that the central bank will mostly destabilize it. Argentine

history gives plenty of reason to think that this is not a bad bet. But can the same be said for

Mexico or Brazil, or for that matter, Turkey or Indonesia? What may work for Argentina may

not work for the others. The debate over currency boards and dollarization illustrates the

obvious, but occasionally neglected fact that the institutions needed by a country are not

independent of that country's history.

(d) Institutions for social insurance

A modern market economy is one where change is constant and idiosyncratic (i.e.,

individual-specific) risk to incomes and employment is pervasive. Modern economic growth

entails a transition from a static economy to a dynamic one where the tasks that workers perform

are in constant evolution and movement up and down in the income scale is frequent. One of the

liberating effects of a dynamic market economy is that it frees individuals from their traditional

entanglements--the kin group, the church, the village hierarchy. The flip side is that it uproots

them from traditional support systems and risk-sharing institutions. Gift exchanges, the fiesta,

and kinship ties--to cite just a few of the social arrangements for equalizing the distribution of

resources in traditional societies--lose much of their social insurance functions. And the risks

that have to be insured against become much less manageable in the traditional manner as

markets spread.

The huge expansion of publicly provided social insurance programs during the 20

century is one of the most remarkable features of the evolution of advanced market economies.

In the United States, it was the trauma of the Great Depression that paved the way for the major

institutional innovations in this area: social security, unemployment compensation, public works,

public ownership, deposit insurance, and legislation favoring unions (see Bordo et al., 1998, 6).

As Jacoby (1998) notes, prior to the Great Depression the middle classes were generally able to

self-insure or buy insurance from private intermediaries. As these private forms of insurance

collapsed, the middle classes threw their considerable political weight behind the extension of

social insurance and the creation of what would later be called the welfare state. In Europe, the

roots of the welfare state reached in some cases to the tail end of the 19

th century. But the

striking expansion of social insurance programs, particularly in the smaller economies most open

to foreign trade, was a post-World War II phenomenon (Rodrik 1998). Despite a considerable

political backlash against the welfare state since the 1980s, neither the U.S. nor Europe has

significantly scaled back these programs.

Social insurance need not always take the form of transfer programs paid out of fiscal

resources. The East Asian model, represented well by the Japanese case, is one where social

insurance is provided through a combination of enterprise practices (such as lifetime

employment and enterprise-provided social benefits), sheltered and regulated sectors (mom-andpop

stores), and an incremental approach to liberalization and external opening. Certain aspects

of Japanese society that seem inefficient to outside observers—such as the preference for smallscale

retail stores or extensive regulation of product markets—can be viewed as substitutes for

the transfer programs that would otherwise have to be provided (as it is in most European

nations) by a welfare state. Such complementarities among different institutional arrangements

within a society have the important implication that it is very difficult to alter national systems in

a piecemeal fashion. One cannot (or should not) ask the Japanese to get rid of their lifetime

employment practices or inefficient retail arrangements without ensuring that alternative safety

nets are in place. Another implication is that substantial institutional changes come only in the

aftermath of large dislocations, such as those created by the Great Depression or the Second

World War.

Social insurance legitimizes a market economy because it renders it compatible with

social stability and social cohesion. At the same time, the existing welfare states in Western

Europe and the United States engender a number of economic and social costs--mounting fiscal

outlays, an "entitlement" culture, long-term unemployment--which have become increasingly

apparent. Partly because of that, developing countries, such as those in Latin America that

adopted the market-oriented model following the debt crisis of the 1980s, have not paid

sufficient attention to creating institutions of social insurance (Rodrik 1999). The upshot has

been economic insecurity and a backlash against the reforms. How these countries will maintain

social cohesion in the face of large inequalities and volatile outcomes, both of which are being

aggravated by the growing reliance on market forces, is a question without an obvious answer at

the moment. But if Latin America and the other developing regions are to carve a different path

in social insurance than that followed by Europe or North America, they will have to develop

their own vision--and their own institutional innovations--to bridge the tension between market

forces and the yearning for economic security.

(e) Institutions of conflict management

Societies differ in their cleavages. Some are made up of an ethnically and linguistically

homogenous population marked by a relatively egalitarian distribution of resources (Finland?).

Others are characterized by deep cleavages along ethnic or income lines (Nigeria?). These

divisions hamper social cooperation and prevent the undertaking of mutually beneficial projects.

Social conflict is harmful both because it diverts resources form economically productive

activities and because it discourages such activities by the uncertainty it generates. Economists

have used models of social conflict to shed light on questions such as: why do governments

delay stabilizations when delay imposes costs on all groups? (Alesina and Drazen 1991); why do

countries rich in natural resources often do worse than countries that are resource-poor? (Tornell

and Lane 1999); why do external shocks often lead to protracted economic crises that are out of

proportion to the direct costs of the shocks themselves? (Rodrik forthcoming).

All of these can be thought of as instances of coordination failure in which social

factions fail to coordinate on outcomes which would be of mutual benefit. Healthy societies

have a range of institutions that make such colossal coordination failures less likely. The rule of

law, a high-quality judiciary, representative political institutions, free elections, independent

trade unions, social partnerships, institutionalized representation of minority groups, and social

insurance are examples of such institutions. What makes these arrangements function as

institutions of conflict management is that they entail a double "commitment technology:" they

warn the potential "winners" of social conflict that their gains will be limited, and assure the

"losers" that they will not be expropriated. They tend to increase the incentives for social groups

to cooperate by reducing the payoff to socially uncooperative strategies.

II. How Are "Good" Institutions Acquired?

As I argued in the preceding section, a market economy relies on a wide array of nonmarket

institutions that perform regulatory, stabilizing, and legitimizing functions. Once these

institutions are accepted as part and parcel of a market-based economy, traditional dichotomies

between market and state or laissez-faire and intervention begin to make less sense. These are

not competing ways of organizing a society's economic affairs; they are complementary elements

that render the system sustainable. Every well-functioning market economy is a mix of state and

market, laissez faire and intervention.

(a) Accepting institutional diversity

A second major implication of the discussion is that the institutional basis for a market

economy is not uniquely determined. Formally, there is no single mapping between the market

and the set of non-market institutions required to sustain it. This finds reflection in the wide

variety of regulatory, stabilizing, and legitimizing institutions that we observe in today's

advanced industrial societies. The American style of capitalism is very different from the

Japanese style of capitalism. Both differ from the European style. And even within Europe,

there are large differences between the institutional arrangements in, say, Sweden and Germany.

It is a common journalistic error to suppose that one set of institutional arrangements

must dominate the others in terms of overall performance. Hence the fads of the decade: with its

low unemployment, high growth, and thriving culture, Europe was the continent to emulate

throughout much of the 1970s; during the trade-conscious 1980s, Japan became the exemplar of

choice; and the 1990s have been the decade of U.S.-style freewheeling capitalism. It is

anybody's guess which set of countries will capture the imagination if and when a substantial

correction hits the U.S. stock market.

The point about institutional diversity has in fact a more fundamental implication. The

institutional arrangements that we observe in operation today, varied as they are, themselves

constitute a subset of the full range of potential institutional possibilities. This is a point that has

been forcefully and usefully argued by Roberto Unger (1998). There is no reason to suppose that

modern societies have already managed to exhaust all the useful institutional variations that

could underpin healthy and vibrant economies. Even if we accept that market-based economies

require certain types of institutions, as listed in the previous section,

such imperatives do not select from a closed list of institutional possibilities. The

possibilities do not come in the form of indivisible systems, standing or falling together.

There are always alternative sets of arrangements capable of meeting the same practical

tests. (Unger, 1998, 24-25)

We need to maintain a healthy skepticism towards the idea that a specific type of institution--a

particular mode of corporate governance, social security system, or labor market legislation, for

example--is the only type that is compatible with a well-functioning market economy.

(b) Two modes of acquiring institutions

How does a developing society acquire functional institutions--functional in the sense of

supporting a healthy, sustainable market-based system? An analogy with technology transfer is

helpful. Think of institution acquisition/building as the adoption of a new technology that allows

society to transforms its primary endowments (land, raw labor, natural resources) into a larger

Perhaps Europe will be back in fashion. As these words were being written, the New York Times published a

major feature article with the title "Sweden, the Welfare State, Basks in a New Prosperity" (October 8, 1999).

bundle of outputs. Let us call this new technology a "market economy," where we understand

that the term encompasses all of the non-market institutional complements discussed previously.

Adoption of a market economy in this broad sense moves society to a higher production

possibilities frontier, and in that sense is equivalent to technical progress in economist's parlance.

But what kind of a technology is a market economy? To over-simplify, consider two

possibilities. One possibility is that the new technology is a general purpose one, that it is

codified, and that it is readily available on world markets. In this case, it can be adopted by

simply importing a blueprint from the more advanced economies. The transition to a market

economy, in this vision, consists of getting a manual with the title "how to build a market

economy" (a.k.a. the "Washington Consensus") and following the directions: remove price

distortions, privatize enterprises, harden budget constraints, enact legal codes, and so on.

A different possibility is that the requisite technology is highly specific to local

conditions and that it contains a high degree of tacitness. Specificity implies that the institutional

repertoire available in the advanced countries may be inappropriate to the needs of the society in

question--just as different relative factor prices in LDC agriculture require more appropriate

techniques than those that are available in the rich countries. Tacitness implies that much of the

knowledge that is required is in fact not written down, leaving the blueprints highly incomplete.

For both sets of reasons, imported blueprints are useless. Institutions need to be developed

locally, relying on hands-on experience, local knowledge, and experimentation.

An example from South Korea's history with technology acquisition nicely illustrates the tacitness of technology.

The Korean shipbuilder Hyundai started out by importing its basic design from a Scottish firm. But it soon found

out that this was not working out. The Scottish design relied on building the ship in two halves, because the original

manufacturer had enough capacity to build only half a ship at a time. When Hyundai followed the same course, it

found out that it could not get the two halves to fit. Subsequent designs imported from European consulting firms

also had problems in that the firms would not guarantee the rated capacity, leading to costly delays. In the end,

Hyundai was forced to rely on in-house design engineers. This case is discussed in Amsden, 1989, 278-89.

The two scenarios are of course only caricatures. Neither the blueprint nor the localknowledge

perspective captures the whole story on its own. Even under the best possible

circumstances, an imported blueprint requires domestic expertise for successful implementation.

Alternatively, when local conditions differ greatly, it would be unwise to deny the possible

relevance of institutional examples from elsewhere. But the dichotomy--whether one

emphasizes the blueprint or the local knowledge aspect of the process--clarifies some key issues

in institution building and sheds light on important debates about institutional development.

Consider the debate on Chinese gradualism.

One perspective, represented forcefully in work by Sachs and Woo (forthcoming),

underplays the relevance of Chinese particularism by arguing that the successes of the economy

are not due to any special aspects of the Chinese transition to a market economy, but instead are

largely due to a convergence of Chinese institutions to those in non-socialist economies. In this

view, the faster the convergence, the better the outcomes. "[F]avorable outcomes have emerged

not because of gradualism, but

despite gradualism" (Sachs and Woo, forthcoming, 3). The

policy message that follows is that China should focus not on institutional experimentation but

on harmonizing its institutions with those abroad.

8 The alternative perspective, perhaps best

developed in work by Qian and Roland, is that the peculiarities of the Chinese model represent

solutions to particular political or informational problems for which no blueprint-style solution

exists. Hence Lau, Qian, and Roland (1997) interpret the dual-track approach to liberalization as

a way of implementing Pareto-efficient reforms: an alteration in the planned economy that

improves incentives at the margin, enhances efficiency in resource allocation, and yet leaves

none of the plan beneficiaries worse off. Qian. Roland, and Xu (1999) interpret Chinese style

Note however that the harmonization that Sachs and Woo (forthcoming) foresee is with the institutions in the rest

of East Asia, not those of the U.S. or Western Europe.

decentralization as allowing the development of superior institutions of coordination: when

economic activity requires products with matched attributes,

9 local experimentation is a more

effective way of processing and using local knowledge.

Sachs, Woo and other members of the convergence school worry about the costs of

Chinese-style experimentalism because they seem to say "well, we already know what a market

economy looks like: it is one with private property and a unified system of prices--just get on

with it." Qian et al, on the other hand, find much to praise in it because they think the system

generates the right incentives for developing the tacit knowledge required to build and sustain a

market economy, and therefore they choose not to be bothered by some of the economic

inefficiencies that may be generated along the way. These two contrasting visions of where the

real action is in the transition to a market economy have been pervasive in our discussions of

policy and have played a determining role in shaping our preferences for

gradualism/experimentalism versus shock therapy.

Although my sympathies in this debate are with the experimentalists, I can also see that

there are dangers with experimentalism. First, one needs to be clear between self-conscious

experimentalism, on the one hand, and delay and gradualism designed primarily to serve

privileged interests, on the other. The dithering, two steps forwards, one step backwards style of

reform that prevails in much of the former Soviet Union and in many Sub-Saharan African

countries is driven not so much by a desire to build better institutions as it is by aversion to

reform. This has to be distinguished from a programmatic effort to acquire and process local

Think again of the problem of fitting the two halves of a ship described in an earlier footnote.

knowledge to better serve local needs. The gradualism that countries like Mauritius

10 or South

Korea

11 have exhibited over their recent history is very different than the "gradualism" of

Ukraine or Nigeria.

Second, it is obviously costly--in terms of time and resources--to build institutions from

scratch when imported blueprints can serve just as well. Experimentalism can backfire if it

overlooks opportunities for institutional arbitrage. Much of the legislation establishing a SEClike

watchdog agency for securities markets, for example, can be borrowed wholesale from those

countries that have already learned how to regulate these markets the hard way--by their own

trial and error. The same goes perhaps for an anti-trust agency, a financial supervisory agency, a

central bank, and many other governmental functions. One can always learn from the

institutional arrangements prevailing elsewhere even if they are inappropriate or cannot be

transplanted. Some societies can go further by adopting institutions that cut deeper--in social

insurance, labor markets, fiscal institutions. Perhaps one reason that a "big bang" worked for

Poland is that this country had already defined its future: it wanted to be a "normal" European

society, with full membership in the European Union. Adopting European institutions wholesale

was not only a means to an end; it was also the ultimate objective the country desired.

The difficult questions, and the trade-offs between the blueprint and the experimentalist

approaches, arise when the attainable objectives are not so clear cut. What kind of a society do

the Chinese want for themselves, and can realistically hope to achieve? How about the

See Wellisz and Saw (1993), Rodrik (1999b, chap. 3), and the discussion in the next sub-section on two-track

reforms in Mauritius.

South Korea is often portrayed as a case where autonomous and insulated technocrats took a series of decisions

without local input. Evans (1995) has usefully emphasized the "embedded" nature of bureaucratic autonomy in

Korea, in particular the dense network of interactions between the bureaucracy and segments of the private sector

that allowed for the exchange of information, the negotiation and renegotiation of policies, and the setting of

priorities.

Brazilians, Indians, or Turks? Local knowledge matters greatly in answering these questions.

Blueprints, best practices, international codes and standards, harmonization can do the trick for

some of the narrowly "technical" issues. But large-scale institutional development by and large

requires a process of discovery about local needs and capabilities.

The blueprint approach is largely top-down, relying on expertise on the part technocrats

and foreign advisors. The local-knowledge approach, by contrast, is bottom down and relies on

mechanisms for eliciting and aggregating local information. In principle, these mechanisms can

be as diverse as the institutions that they help create. But I would argue that the most reliable

forms of such mechanisms are participatory political institutions. Indeed, it is helpful to think of

participatory political institutions as meta-institutions that elicit and aggregate local knowledge

and thereby help build better institutions.

It is certainly true that non-democratic forms of government have often succeeded

admirably in the task of institution building using alternative devices. The previously mentioned

examples of South Korea (with its "embedded" bureaucratic autonomy) and China (with its

decentralization and experimentalism) come immediately to mind. But the broad, cross-national

evidence indicates that these are the exceptions rather than the rule. Nothing prevents

authoritarian regimes from using local knowledge; the trouble is that nothing compels them to do

so either.

The case of Mauritius illustrates nicely how participatory democracy helps build better

institutions that lay the foundation for sustainable economic growth. The initial conditions in

Mauritius were inauspicious from a number of standpoints. The island was a monocrop

economy in the early 1960s and faced a population explosion. A report prepared by James

Meade in 1961 was quite pessimistic about the island's future, and argued that "unless resolute

measures are taken to solve [the population problem], Mauritius will be faced with a catastrophic

situation" (Meade 1961, 37). Mauritius is also an ethnically and linguistically divided society

and its independence in 1968 was preceded by a series of riots between Muslims and Creoles.

Mauritius' superior economic performance has been built on a peculiar combination of

orthodox and heterodox strategies. To an important extent, the economy's success was based on

the creation of an export processing zone (EPZ) operating under free-trade principles, which

enabled an export boom in garments to European markets and an accompanying investment

boom at home. Yet the island's economy has combined the EPZ with a domestic sector that was

highly protected until the mid-1980s.

12 Mauritius is essentially an example of an economy that

has followed a two-track strategy not too dissimilar to that of China. This economic strategy was

in turn underpinned by social and political arrangements that encouraged participation,

representation and coalition-building. Rather than discouraging social organization,

governments have encouraged it. In the words of Miles (1999), Mauritius is a "supercivil

society," with a disproportionately large number of civil society associations per capita.

The circumstances under which the Mauritian EPZ was set up in 1970 are instructive, and

highlight the manner in which participatory political systems help design creative strategies for

building locally adapted institutions. Given the small size of the home market, it was evident

that Mauritius would benefit from an outward-oriented strategy. But as in other developing

countries, policy makers had to contend with the import-substituting industrialists who had been

propped up by the restrictive commercial policies of the early 1960s prior to independence.

Gulhati (1990, Table 2.10) reports an average effective rate of protection in 1982 for manufacturing in Mauritius

of 89%, with a range of -24% to 824%.

These industrialists were naturally opposed to relaxing the trade regime.

A Washington economist would have advocated across-the-board liberalization, without

regard to what that might do the precarious political and social balance of the island. Instead, the

Mauritian authorities chose the two-track strategy. The EPZ scheme in fact provided a neat way

around the political difficulties. The creation of the EPZ generated new opportunities of trade

and of employment, without taking protection away from the import-substituting groups and

from the male workers who dominated the established industries. The segmentation of labor

markets early on between male and female workers--with the latter predominantly employed in

the EPZ--was particularly crucial, as it prevented the expansion of the EPZ from driving wages

up in the rest of the economy, thereby disadvantaging import-substituting industries. New profit

opportunities were created at the margin, while leaving old opportunities undisturbed. There

were no identifiable losers. This in turn paved the way for the more substantial liberalizations

that took place in the mid-1980s and in the 1990s.

Mauritius found its own way to economic development because it created social and

political institutions that encouraged participation, negotiation, and compromise. That it did so

despite inauspicious beginnings and following a path that diverged from orthodoxy speaks

volumes about the importance of such institutions. The following section presents some crossnational

evidence suggesting that democracy tends in fact to be a reliable mechanism for

generating such desirable outcomes.

III. Participatory Political Regimes Deliver Higher-Quality Growth

In policy circles, the discussion on the relationship between political regime type and

economic performance inevitably gravitates toward the experience of a handful of economies in

East and Southeast Asia, which (until recently at least) registered the world’s highest growth

rates under authoritarian regimes. These countries constitute the chief exhibit for the argument

that economic development requires a strong hand from above. The deep economic reforms

needed to embark on self-sustaining growth, this line of thought goes, cannot be undertaken in

the messy push and pull of democratic politics. Chile under General Pinochet is usually exhibit

no. 2.

A systematic look at the evidence, however, yields a much more sanguine conclusion.

While East Asian countries have prospered under authoritarianism, many more have seen their

economies deteriorate—think of Zaire, Uganda, or Haiti. Recent empirical studies based on

samples of more than 100 countries suggest that there is little reason to believe democracy is

conducive to lower growth over long time spans.

13 Neither is it the case that economic reforms

are typically associated with authoritarian regimes (Williamson 1994). Indeed, some of the most

successful reforms of the 1980s and 1990s were implemented under newly elected democratic

governments—think of the stabilizations in Bolivia (1985), Argentina (1991), and Brazil (1994),

for example. Among former socialist economies too, the most successful transitions have

occurred in the most democratic countries.

Helliwell (1994) and Barro (1996) try to control for the endogeneity of democracy in estimating the effect of the

latter on growth. Helliwell finds that democracy spurs education and investment, but has a negative (and

insignificant) effect on growth when investment and education are controlled. On balance, he finds no “systematic

net effects of democracy on subsequent economic growth.” Barro finds a non-linear relationship, with growth

increasing in democracy at low levels of democracy and decreasing in democracy at higher levels. The turning point

comes roughly at the levels of democracy existing in Malaysia and Mexico (in 1994), and somewhat above South

Africa’s level prior to its transition. A more recent paper by Chowdhurie-Aziz (1997) finds a positive association

between the degree of non-elite participation in politics and economic growth. See also Tavares and Wacziarg

(1996) who estimate a system of simultaneous equations and find a positive effect of democracy on growth through

the channels of enhanced education, reduced inequality, and lower government consumption.

In fact, the record is even more favorable to participatory regimes than is usually

acknowledged. This section provides evidence in support of the following assertions:

1. Democracies yield long-run growth rates that are more predictable.

2. Democracies produce greater short-term stability.

3. Democracies handle adverse shocks much better.

4. Democracies deliver better distributional outcomes.

The first of these implies that economic life is less of a crapshoot under democracy. The second

suggests that, whatever the long-run growth level of an economy, there is less instability in

economic outcomes under democratic regimes than under autocracies. The third finding

indicates that political participation improves an economy’s capacity to adjust to changes in the

external environment. The final point suggests that democracies produce superior distributional

outcomes.

Taken together, these results provide a clear message: participatory political regimes

deliver higher-quality growth. I would contend that they do so because they produce superior

institutions better suited to local conditions.

(a) Democracy and long-term performance

Figure 1 shows a scatter plot for a sample of 90 countries. The figure shows the partial

relationship between a country’s level of democracy and its growth rate of GDP per capita

during the 1970-89 period, after initial income, education, and regional effects are controlled for.

Democracy is measured on a scale of 0 to 1, using the Freedom House index of political rights

and civil liberties. While the slope of the relationship is positive and statistically significant, this

Most of the evidence presented in this section comes from Rodrik (1997, 1999c, and forthcoming).

result is not very robust. As is clear from the figure, removing Botswana--which is an important

outlier--would make a big difference to the results. This is in line with existing results in the

literature, which suggest that there is no strong, determinate relationship between political

participation and average levels of long-run growth.

Looking at individual cases, it becomes quickly evident why this is so. Among highgrowth

countries, Taiwan, Singapore, and Korea rank low in terms of democracy (during the

period covered by the regression), this being the source of the conventional wisdom among

policymakers reported above. But some other countries, Botswana and Mauritius in particular,

have done equally well or even better under fairly open political regimes. (Note that the

rankings in this figure have to be interpreted relative to the benchmarks established by the

presence of the other controls in the regression.) Poor performers can similarly be found at

either end of the democracy spectrum: South Africa and Mozambique have done poorly under

authoritarian regimes, Papua New Guinea and Jamaica under relatively democratic ones.

Hence mean long-run growth rates tend not to depend systematically on political regime

type. But this is only part of the broader picture. A different question is whether democracy is

the safer choice in the following sense: is the cross-national variance in long-run growth

performance smaller under democracies than it is under autocracies? Since mean growth rates

do not differ, a risk-averse individual would unambiguously prefer to live under the regime

where expected long-run growth rates cluster more closely around the mean.

I first divide the country sample into two roughly equal-sized groups. I call those with

values of the democracy index less than 0.5 “autocracies” (n=48), and those with values greater

or equal to 0.5 “democracies” (n=45). The top panel in Table 1 shows the coefficients of

variation of long-run growth rates, computed across countries for the 1960-89 period, for the two

samples. The first row shows the unconditional coefficients of variation, without any controls

for determinants of growth rates. The second row displays the conditional version of the same,

where the variation now refers to the unexplained component from a cross national regression

(separate for each sample) with the following control variables: initial GDP per capita, initial

secondary school enrollment ratio, and regional dummies for Latin America, East Asia, and sub-

Saharan Africa. I find that the coefficient of variation (whether conditional or unconditional) is

substantially higher for autocracies than it is for democracies.

Since countries with authoritarian regimes tend to have lower incomes, perhaps this result

reflects the greater randomness in the long-run growth rates of poor countries. To check against

this possibility, I divided countries differently. First, I regressed the democracy index on income

and secondary enrollment levels across countries (R

2 = 0.57). Then I regrouped my sample of

countries according to whether their actual democracy levels stood below or above the regression

line. Countries above (below) the regression line are those with greater (less) political

participation than would be expected on the basis of their income and educational levels. In the

bottom panel of Table 1, these two groups are labeled “high democracy” (n=49) and “low

democracy” (n=44) respectively. The coefficients of variation for long-term growth rates are

then calculated for each group in the same way as before. Our results remain qualitatively

unchanged, although the gap between the two groups shrinks somewhat: the coefficient of

variation is smaller in countries with greater political participation (where “greater” now refers to

the benchmark set by the cross-national regression relating participation levels to income and

education).

The bottom line is that living under an authoritarian regime is a riskier gamble than living

under a democracy.

(b) Democracy and short-term performance

A point similar, but not identical, to the one just discussed was anticipated by Sah (1991),

who argued that de-centralized political regimes (and democracies in particular) should be less

prone to volatility. The rationale behind this idea is that the presence of a wider range of

decision-makers results in greater diversification and hence less risk in an environment rife with

imperfect information. This is a point similar to the one made above regarding the importance of

local knowledge. Note that this specific argument is about short-term volatility in economic

performance, and not about the dispersion in long-term growth rates which was the focus of the

previous section.

To determine the relationship between regime type and volatility in short-run economic

performance, I focus on three national-accounts aggregates: (a) real GDP; (b) real consumption;

and (c) investment. (All data are from the Penn World Tables, Mark 5.6.) In each case,

volatility is measured by calculating the standard deviation of annual growth rates of the relevant

aggregate over the 1960-89 period (more accurately, by taking the standard deviation of the first

differences in logs). Then each measure of volatility is regressed on a number of independent

variables, including our measure of participation (democracy). The other independent variables

included are: log per-capita GDP, log population, exposure to external risk, and dummies for

Latin America, East Asia, sub-Saharan Africa, and OECD.

Table 2 shows the results. The estimated coefficient on the measure of democracy is

negative and statistically significant in all cases. A movement from pure autocracy (democracy

= 0) to pure democracy ( =1) is associated with reductions in the standard deviations of growth

rates of GDP, consumption, and investment of 1.3, 2.3, and 4.4 percentage points, respectively.

These effects are fairly sizable. Figure 2 shows a partial scatter plot which helps identify where

different countries stand. Long-standing democracies such as India, Costa Rica, Malta, and

Mauritius have experienced significantly less volatility than countries like Syria, Chile, or Iran,

even after controlling for country size and external shocks.

Moreover, as the last column of Table 2 shows, causality seems to run directly from

regime type to volatility (rather than vice versa). In this column I have used secondary

enrollment ratio as an instrument for democracy (in addition to the other independent variables

mentioned earlier). This variable has all the properties of a desirable instrument, as it is well

correlated with democracy but virtually uncorrelated with the error term from the OLS

regression. With democracy instrumented in this fashion, the estimated coefficient actually

doubles in absolute value.

The evidence strongly suggests, therefore, that democracy is conducive to lower volatility

in economic performance.

The late 1970s were a watershed for most developing economies. A succession of

external shocks during this period left many of them in severe payment difficulties. In some

cases, as in most of Latin America, it took almost a decade for macroeconomic balances to be

restored and for growth to resume. The question I now pose is whether democratic and

participatory institutions helped or hindered adjustment to these shocks of external origin.

The main thing I am interested in explaining is the extent of economic collapse following

an external shock. In another paper (Rodrik forthcoming), I have explored how social cleavages

Similar findings have also been reported in Chandra (1998) and Quinn and Woolley (1998).

and domestic institutions of conflict management mediate the effects of shocks on economic

performance. Here I focus on the role of participatory institutions specifically.

In a recent review of the growth experience of developing countries, Pritchett (1997) has

looked for breaks in trend growth rates. These breaks tend to coalesce around the mid- to late-

1970s, with 1977 as the median break year. I use the difference in growth rates before and after

the break as my dependent variable.

The basic story in Rodrik (forthcoming) is that the adjustment to shocks will tend to be

worse in countries with deep latent social conflicts and with poor institutions of conflict

management. Consequently, such countries will experience larger declines in growth rates

following shocks. These ideas are tested by regressing the change in growth on indicators of

latent conflict and on proxies for institutions of conflict management (in addition to other

variables

16). Figure 3 displays a sample partial scatter plot, showing the relationship between

ethnic cleavages and the growth decline. Controlling for other variables, there is a systematic

relationship between these two: countries with greater ethnic and linguistic fragmentation

experienced larger declines in economic growth.

Our interest in democratic institutions in this context derives from the idea that such

institutions provide ways of regulating and managing social conflicts through participatory

means and the rule of law, and hence dissipate the adverse consequences of external shocks. To

test this hypothesis, we check to see whether our measure of democracy—this time restricted to

the 1970s only, to avoid possible reverse-causality—is related to changes in growth rates

subsequent to the shocks. The partial scatter plot shown in Figure 4, covering 101 countries,

Each regression in this paper includes the following variables on the right-hand side in addition to those

specifically discussed: log GDP per-capita in 1975, growth rate prior to break year, measure of external shocks

during the 1970s, ethno-linguistic fragmentation (

elf60), and regional dummies for Latin America, East Asia, and

sub-Saharan Africa.

suggests a clear affirmative answer. Countries with greater political freedoms during the 1970s

experienced lower declines in economic growth when their trend growth rate changed. The

relationship is highly significant in statistical terms; the t-statistic on the estimated coefficient on

democracy is 3.53, with a p-value of 0.001. Figure 5 shows the results when sub-Saharan

African countries are excluded from the sample. The reason to exclude these is both concern

with data quality and the possibility that the relationship is driven by a few African countries

with extreme values. But the relationship holds just as well in the restricted sample: the partial

slope coefficient is virtually unchanged and the t-statistic is almost as high (3.32). As these two

figures show, the hardest hit countries tended to be those with few political liberties (relative to

what would be expected of countries at their levels of income), such as Syria, Algeria, Panama,

and Gabon. Countries with open political regimes, such as Costa Rica, Botswana, Barbados, and

India, did much better.

These results are perhaps surprising in view of the common presumption that it takes

strong, autonomous governments to undertake the policy adjustments required in the face of

adversity. They are less surprising from the perspective articulated above: adjustment to shocks

requires managing social conflicts, and democratic institutions are useful institutions of conflict

management.

To probe the issues more deeply, I investigate the relationship between declines in

growth and three other aspects of political regime: (a) the degree of institutional (de jure)

independence of the executive; (b) the degree of operational (de facto) independence of the

executive; and (c) the degree to which non-elites can access political institutions. These three

variables come originally from the Polity III data (see Jaggers and Gurr, 1995), and have been recoded

on a scale of 0 to 1 for the purposes of the current exercise. As before, I use the averages

of the values reported for each country during the 1970s. Note that these three indicators are

correlated with the Freedom House measure of democracy (which I have been using up to this

point) in the expected manner: independence of the executive tends to be lower in democracies,

and avenues of non-elite participation are larger. But there are interesting exceptions. The

United States, for example, ranks highest not only on the democracy index, but also in the degree

of institutional (de jure) independence of the executive. Other democracies with relatively

autonomous executives (de jure) are France, Canada, and Costa Rica. By contrast, South Africa

is coded as having had (during the 1970s) little democracy and little executive autonomy.

A nagging question in the literature on political economy is whether an insulated and

autonomous executive is necessary for the implementation of economic reforms.

17 This question

is somewhat distinct from the question about democracy proper, since, as the examples just

mentioned illustrate, one can conceive of democratic systems that nonetheless have wellinsulated

executives. Therefore the Polity III indicators are particularly relevant.

The results shown in Figures (6)-(8) are again somewhat surprising—at least when

approached from the technocratic perspective. I find that more significant growth declines are

associated with greater institutional and operational independence of the executive and lower

levels of political access by non-elites.

18 The estimated coefficients are statistically highly

significant in all cases. Therefore, not only do we not find that executive autonomy results in

better economic management, the results strongly suggest the converse: political regimes with

lower executive autonomy and more participatory institutions handle exogenous shocks better!

This literature is briefly surveyed and evaluated in Rodrik (1996).

Moreover, the estimated signs on these variables remain unchanged if the Freedom House index of democracy is

entered separately in the regression.

The finding on political participation echoes the argument in Isham et al. (1997) that more citizen voice results in

projects with greater economic returns.

This might be part of the explanation for why democracies experience less economic instability

over the long run (as demonstrated in the previous sub-section).

It is worth mentioning in passing that the recent experience in East Asia strongly

validates these results. South Korea and Thailand, with more open and participatory political

regimes handled the Asian financial crisis significantly better than Indonesia. I have argued in

Rodrik (1999b) that democracy helped the first two countries manage the crisis for at least three

reasons. First, it facilitated a smooth transfer of power from a discredited set of politicians to a

new group of government leaders. Second, democracy imposed mechanisms of participation,

consultation, and bargaining, enabling policy makers to fashion the consensus needed to

undertake the necessary policy adjustments decisively. Third, because democracy provides for

institutionalized mechanisms of “voice,” the Korean and Thai institutions obviated the need for

riots, protests, and other kinds of disruptive actions by affected groups, as well as lowering the

support for such behavior by other groups in society.

(d) Democracy and distribution

Finally, I turn to distributional issues. I have shown in Rodrik (1999c) that democracy

makes an important difference to the distribution of the enterprise surplus in the manufacturing

sectors of national economies. In particular, there is a robust and statistically significant

association between the extent of political participation and wages received by workers,

controlling for labor productivity, income levels, and other possible determinants. The

association exists both across countries and over time within countries (i.e. in panel regressions

with fixed effects as well as in cross-section regressions). Countries with greater political

participation than would have been predicted from their income levels such as India, Israel,

Malta, and Cyprus also have correspondingly higher wages relative to productivity. Some

countries at the other end of the spectrum—lower-than-expected values for the democracy index

and low wages—are Syria, Saudi Arabia, Turkey, and Mexico. Moving from Mexico’s level of

democracy to that of the U.S. is associated with an increase in wages of about 30 percent.

Instrumental-variables and event-study evidence suggests strongly that the relationship is causal;

that is, changes in political regime cause a redistribution of the enterprise surplus towards

workers.

Figure 9 shows a different type of evidence relating to economy-wide inequality. One

problem with the evidence on the functional distribution of income within manufacturing

(discussed above) is that a pro-labor distribution in manufacturing can go hand in hand with a

more regressive distribution overall. This would be the case, for example, where pro-labor

policies create a "labor aristocracy" to the detriment of the informal and rural sector worker.

Figure 9 is quite comforting on that score. It shows that the relationship between democracy and

economy-wide inequality (measured by the Gini coefficent from the high-quality Deininger-

Squire data set) is in fact negative. More participatory regimes produce greater equality not only

within the modern (manufacturing) sector, but throughout the economy. And they do so--as the

previous evidence indicates--without cost to economic growth and while producing greater

stability and resilience overall.

IV. Concluding remarks

Institutional reform has become the buzzword of the day. Policy advisors and

international financial institutions (IFIs) find it tempting to extend their advice and conditionality

to a broad range of institutional areas, including monetary and fiscal institutions, corporate

governance, financial and asset market supervision, labor-market practices, business-government

relations, corruption, transparency, and social safety nets. While such efforts have got the basic

diagnosis right--the development of a market-based economy requires a heavy dose of institution

building--they suffer from two weaknesses.

First, it is not clear whether the IFIs can overcome their bias towards a particular, "neoliberal"

social-economic model--a model that is approximated, if not fully replicated, in the real

world by the United States. It is telling that when South Korea recently came under IMF

conditionality, the IMF asked the country to undertake an ambitious range of reforms in trade

and capital accounts, government-business relations, and labor-market institutions that entailed

remolding the Korean economy in the image of a Washington economist’s idea of a free-market

economy. This model is not only untested, it forecloses some development strategies that have

worked in the past, and others that could work in the future. If Korea, a country with an

exemplary development record, is subject to pressures of this kind, one can imagine what is in

store for small countries with more checkered economic histories. As I have argued in this paper,

an approach that presumes the superiority of a particular model of a capitalist economy is quite

restrictive in terms of the range of institutional variation that market economies can (and do)

admit.

Second, even if the IFIs could shed their preference in favor of the neo-liberal model,

there would remain an organizational bias towards providing similar, even if not identical, advice

to client governments. It would be difficult for institutions like the World Bank and the IMF to

adopt a "let a hundred flowers bloom" strategy, as it would appear that some countries are being

treated more or less favorably. The result is likely to be at best unfriendly to institutional

experimentation on the part of client governments.

To be sure, some institutional convergence can be useful and proper. No one can be

seriously against the introduction of proper accounting standards or against improved prudential

supervision of financial intermediaries. The more serious concern with regard to IFI

conditionality is that such standards will act as the wedge with which a broader set of

institutional preferences--in favor of open capital accounts, deregulated labor markets, armslength

finance, American-style corporate governance, and hostile to industrial policies--will be

imparted on the recipient countries.

My focus on the importance of local knowledge, and on participatory democracy as a

meta-institution for eliciting and aggregating it, suggests that conditionality is perhaps better

targeted at basic political freedoms. I have shown in this paper that democracies perform better

on a number of dimensions: they produce less randomness and volatility, they are better at

managing shocks, and they yield distributional outcomes that are more desirable. One

interpretation of these results, and the one that I have emphasized throughout, is that democracy

helps build better institutions. While I am a great believer in institutional diversity, I see no

argument that would make it appropriate for some governments to deny their citizens basic

political rights such as freedom of speech, the right to vote and stand for political office, or

freedom of association. If there is one area where institutional conditionality is both appropriate

and of great economic value, it seems to me that this is it.

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Collapses," Journal of Economic Growth, 4(4), December 1999, forthcoming.

(

http://www.ksg.harvard.edu/rodrik/conftext.pdf)

Sachs, Jeffrey D., and Wing Thye Woo, "Understanding China's Economic Performance,"

Journal of Policy Reform, forthcoming.

Sah, Raaj K., “Fallibility in Human Organizations and Political Systems,” Journal of Economic

Perspectives, 5(2), Spring 1991, 67-88.

Tavares, Jose, and Romain Wacziarg, “How Democracy Fosters Growth,” Harvard University,

August 1996.

Temple, Jonathan, and Paul Johnson, "Social Capability and Economic Growth," Quarterly

Journal of Economics, August 1998, 113(3), 965-90.

Tornell, Aaron, and Philip R. Lane, "The Voracity Effect," American Economic Review, 89(1),

March 1999, 22-46.

Unger, Roberto Mangabeira, Democracy Realized: The Progressive Alternative, Verso, London

and New York, 1998.

Wellisz, Stanislaw, and Philippe Lam Shin Saw, "Mauritius," in Ronald Findlay and Stanislaw

Wellisz, eds., The Political Economy of Poverty, Equity, and Growth: Five Open Economies,

Oxford University Press, New York, 1993.

Williamson, John, ed., The Political Economy of Policy Reform, Washington, DC, Institute for

International Economics, 1994.

Figure 1: Partial correlation between democracy and economic growth, 1970-89

(controlling for initial income, education, and regional dummies)

coef = .02196586, se = .00923168, t = 2.38

e( gr7089 | X)

e( dem7089 | X )

-.462324 .478619

-.038903

.062969

Hungary

Poland

Yugoslav

Chile

Syria

Iran, I.

Panama

Mozambiq

South af

Algeria

Uruguay

STinagiwapanor

Jordan

Argentin

Korea

Paraguay

Haiti

Swazilan

Central

Niger

Mexico

Tunisia

Zaire

Peru

Spain

Myanmar

Togo

Ghana

Finland

Malawi

Uganda

Philippi

Seychell

United S

Guyana

Israel

Bolivia

Mali

Zambia

Guatemal

Australi

Pakistan

Brazil

Zimbabwe

Germany,

Sierra L

Indonesi

Denmark

New Zeal

Cyprus

Thailand

Ecuador

Canada

Switzerl

MTaulrakyesyia

Sweden

France

Trinidad

Netherla

Greece

Venezuel

Belgium

Japan

El Salva

Italy

Banglade

United K

Senegal

Norway

Kenya

Honduras

Barbados

Fiji

Austria

Iceland

Portugal

Lesotho

Sri Lank

Ireland

Colombia

Jamaica

Malta

Mauritiu

Dominica

Papua Ne

Costa Ri

India

Botswana

coef = -.02327064, se = .0073816, t = -3.15

e( sdc | X)

e( dem7089 | X )

-.366946 .524269

-.024103

.046139

Syria

Haiti

Chile

Algeria

Panama

Iran, I.

Yugoslav

Jordan

Somalia

Singapor

Benin

Gabon

Uruguay

Paraguay

Congo

Nicaragu

Turkey

Spain

Central

Tunisia

Chad

Burundi

Mauritan

Finland

Korea

Mali

Guyana

Niger

IAnrdgoennetisni

Guinea-B

Peru

Portugal

Guatemal

Zaire

Malawi

Philippi

Togo

Cape ver

Switzerl

South af

Mexico

Cote d'I

Greece

New Zeal

Bolivia

Iceland

Egypt

Uganda

Cameroon

France

Sweden

Ghana

Denmark

Germany,

Australi

Ecuador

Ethiopia

Norway

CMaanlaaydsaia

United S

Italy

Netherla

Madagasc

Thailand

Morocco

Zambia

El Salva

Liberia

Pakistan

Austria

Honduras

ZUimnibteadb wKe

Nepal

Tanzania

Ireland

BBaranFzgiilljiade

TrinidKaednya

Japan

Burkina

Venezuel

Cyprus

Senegal

Israel

Jamaica

CSoril oLmabnika

Dominica

Papua Ne

Nigeria

Barbados

Malta

Mauritiu

Costa Ri

India

Gambia

Figure 2: Partial correlation between democracy and consumption volatility

coef = -1.8392835, se = .83629833, t = -2.2

e( differen | X)

e( elf60 | X )

-.557479 .553313

-5.65361

4.30598

Madagasc

KoBrueraundi

Somalia

Rwanda

Jordan

Mauritan

Egypt

Portugal

Haiti

JaMpaaltna

Dominica

Jamaica

Ireland

Colombia

Costa Ri

Greece

Italy

Iceland

Botswana

Germany,

Norway

Brazil

Denmark

Tunisia

PHaornadguraays

Sweden

Netherla

El Salva

Austria

Taiwan

Singapor

Barbados

Chile

Syria

Zimbabwe

Malawi

Nicaragu

Venezuel

Israel

Finland

Turkey

EtThoiogpoia

Congo

Uruguay

Burkina

Benin

Gambia

Panama

Mozambiq

Cyprus

Mauritiu

FNraignecre

Central

Gabon

Guinea

Ghana

Mexico

Senegal

Sierra L

Argentin

Algeria

United K

Australi

Angola

Thailand

Sri Lank

Mali

Nigeria

Kenya

Zambia

New Zeal

Malaysia

Morocco

Spain

Chad

Cameroon

Zaire

Philippi

Tanzania

Cote d'I

Ecuador

Indonesi

Uganda

Pakistan

Guyana

South af

USnwiteitzde Srl Belgium

Nepal

Peru

Trinidad

Guatemal

Bolivia

Canada

India

Figure 3: Ethnic cleavages and growth differentials (pre- and post- break year in

trend growth)

coef = 3.4063786, se = .96476657, t = 3.53

e( differen | X)

e( democ70s | X )

-.548494 .667472

-5.12568

4.59929

Syria

Gabon

Algeria

Panama

Spain

Uruguay

Peru

Jordan

Tunisia

Chile

Argentin

Ecuador

Mozambiq

Somalia

Benin

SCinognagpoor

Uganda

Central

South af

Cote d'I

Taiwan

Haiti

Egypt

Brazil

Paraguay

Portugal

Burundi

Nicaragu

Mexico

Morocco

Bolivia

Nepal

Guinea

Mali

Chad

Korea

Zaire

Cyprus

Finland

Mauritan

Angola

Israel

Zimbabwe

Niger

Togo

Rwanda

Ghana

Malawi

Greece

Turkey

Philippi

Pakistan

USnwiittezde rSl

Sierra L

France

Honduras

Cameroon

Canada

Italy

Trinidad

Tanzania

Zambia

Sweden

Senegal

Australi

Thailand

New Zeal

Germany,

Japan

Indonesi

Guatemal

Denmark

Belgium

Netherla

Madagasc

Norway

United K

Venezuel

Iceland

Austria

Guyana

Ethiopia

Nigeria

Kenya

Ireland

Mauritiu

El Salva

Malaysia

Dominica

Sri Lank

Colombia

Malta

Jamaica

Burkina

Barbados

India

Botswana

Costa Ri

Gambia

Figure 4: Democracy and growth differentials (pre- and post- break year in

trend growth)

coef = 3.533285, se = 1.0630298, t = 3.32

e( differen | X)

e( democ70s | X )

-.546667 .428284

-4.49398

3.69551

Syria Algeria

Uruguay

Panama

Tunisia

Spain

Jordan

Chile

Peru

Singapor

Argentin

Ecuador

Haiti

Nicaragu

TFainiwlaannd

Egypt

Morocco

Portugal

Brazil

Paraguay

Mexico

Israel

Switzerl

New Zeal

Philippi

Bolivia

Nepal

VIenndeoznueesli

Sweden

Korea

United S

Cyprus

Australi

Trinidad

Italy

France

Germany,

Turkey

Denmark

United K

Canada

Norway

Honduras

Iceland

Guyana

Greece

Netherla

Thailand

Belgium

Austria

Ireland

Pakistan

Guatemal

Japan

Sri Lank

Dominica

Barbados

Malaysia

El Salva

Jamaica

Colombia

India

MaCltaosta Ri

Figure 5: Democracy and growth differentials (pre- and post- break year in

trend growth), excluding sub-Saharan African countries

coef = -2.3612801, se = .9549911, t = -2.47

e( differen | X)

e( mono_x | X )

-.559218 .443639

-5.22294

4.47472

Switzerl

Togo

Malaysia

Dominica

Botswana

Honduras

India

Jamaica

Burundi

Zimbabwe

Ethiopia

Niger

Burkina

Brazil

Ghana

Malta

Thailand

Turkey

Peru

South af

Trinidad

Uruguay

Ireland

Pakistan

Israel

GJaampabnia

Sri Lank

Iceland

Guyana

Belgium

Italy

NAeuws tZrieaal

United K

Norway

Finland

Netherla

Denmark

Australi

Germany,

Taiwan

Sweden

Argentin

Mali

Chile

Colombia

Nigeria

Greece

Guatemal

Cameroon

Bolivia

Tanzania

Madagasc

Malawi

Benin

Guinea

IndZoanireesi

Congo

Zambia

Algeria

Philippi

Haiti

Nepal

Spain

PCaennatrmala

Kenya

Chad

Uganda

France

Ecuador

Senegal

Sierra L

Korea

Jordan

Singapor

Paraguay

MGoraobcocno

Cote d'I

El Salva

Egypt

Nicaragu

Rwanda

Costa Ri

Tunisia

Somalia

Cyprus

Syria

Mexico

Portugal

Venezuel

Canada

United S

Figure 6: Institutional (de jure) independence of the executive and growth

differentials (pre- and post- break year in trend growth)

coef = -2.3367757, se = .63331585, t = -3.69

e( differen | X)

e( xconst_x | X )

-.833472 .603293

-5.22294

4.47472

Gambia

Jamaica

Botswana

Malaysia

India

Costa Ri

Zimbabwe

Sri Lank

Colombia

Guyana

Malta

South af

Trinidad

Cyprus

Ireland

VEethnieozpuiael

Tanzania

Israel

Honduras

Turkey

El Salva

Burkina

Japan

Iceland

Italy

Dominica

Austria

Norway

United K

Kenya

Denmark

Finland

GNeerwm aZneya,l

Netherla

Senegal

Madagasc

Belgium

Niger

ISndwoendeesni

ACusotnragloi

Thailand

Sierra L

Togo

Switzerl

Canada

Guatemal

Ghana

Egypt

United S

Burundi

Guinea

Haiti

Nepal

Malawi

Singapor

Mali

Pakistan

Taiwan

Ecuador

Rwanda

Chad

Portugal

Zaire

Cameroon

Central

Nigeria

Mexico

Philippi

Uruguay

Uganda

Zambia

Bolivia

Somalia

Korea

Paraguay

Chile

France

Benin

Greece

Jordan

Panama

Nicaragu

Peru

Argentin

Morocco

Cote d'I

STpuaniisnia

Brazil

Algeria

Gabon

Syria

Figure 7: Operational (de facto) independence of the executive and growth

differentials (pre- and post- break year in trend growth)

coef = 2.4286182, se = .7411522, t = 3.28

e( differen | X)

e( parcom_x | X )

-.568213 .94865

-5.22294

4.47472

Syria

STpuaninisia

Algeria

Gabon

Argentin

Uruguay

Taiwan

Jordan

Peru

Chile

Brazil

Panama

Cote d'I

Dominica

Somalia

Egypt

South af

Mexico

Nepal

Bolivia

Benin

Congo

Philippi

Nigeria

Singapor

Uganda

Nicaragu

Trinidad

Korea

Burundi

CZeanmtrbaila

Kenya

Malta

Chad

Greece

Portugal

Rwanda

Zaire

Paraguay

Cameroon

Israel

Haiti

Mali

Sierra L

Madagasc

Ghana

Malawi

MTourrokcecyo

Zimbabwe

Senegal

Tanzania

Guinea

United S

Pakistan

Sweden

Switzerl

Niger

Ecuador

Thailand

Australi

Germany,

Canada

Netherla

DFenramnacrek

Finland

Norway

Ethiopia

Guatemal

NAeuws tZrieaal

United K

Belgium

Togo

El Salva

Italy

Sri Lank

Iceland

Japan

Indonesi

Burkina

Ireland

Cyprus

Guyana

Honduras

India

Venezuel

Colombia

Malaysia

Costa Ri

Jamaica

Botswana

Gambia

Figure 8: Ability of non-elites to access political institutions and growth

differentials (pre- and post- break year in trend growth)

Figure 9: Partial association between democracy and economy-wide inequality (Gini

coefficient), 1985-89

Controls: log gdp/cap, log gdp/cap squared, urbanization; dummies for Latin America, East

Asia, SSA, socialist countries, and oil exporters.

coef = -11.764853, se = 4.6754887, t = -2.52

e( giniall | X)

e( democnew | X )

-.48638 .310544

-13.3838

16.0142

Panama

Chile

Bahamas,

Tunisia

Jordan

South Af

SingAalpgoerria

Malawi

Malaysia

Mexico

Banglade

Ghana

Finland

Cote d'I

Morocco

Sri Lank

GUunaitteedm Sal

China

Lesotho

Cananda

Norway

Germany,

Indonesi

Korea

Turkey

Columbia

Pakistan

Australi

Sweden

Luxembou

Brazil

Austri

Ecuador

Denmark

Japan

Itlay

Greece

Israel

Peru

Poland

Hungary

New Zeal

Thailand

Netherla

Bolivia

United K

Jamaica

Uganda

Honduras

Belgium

Spain

Nigeria

Uruguay

IArDeroglamennidntiinca

Costa Ri

Venezuel

Mauritiu

India

BoPtshwiliapnpai

Table 1

Variance of economic performance under different political regimes

coeff. of variation of long-run economic growth rates under:

autocracies democracies

unconditional

1.05 0.54

conditional

0.70 0.48

"low democracy" "high democracy"

unconditional

1.02 0.61

conditional

0.64 0.54

Note: See text for explanation.

Table 2

Political participation and volatility of economic

performance

(estimated coefficient on democracy from multiple regression)

dependent variable

standard deviation of growth

rate of:

real GDP consumption investment consumption

OLS OLS OLS IV

democracy

-1.31** -2.33** -4.36* -4.97**

(0.60) (1.09) (1.61) (2.10)

101 101 101 88

Note: Additional regressors (not shown): log per-capita GDP, log

population, a measure of exposure to external risk, dummies for

Latin America, East Asia, sub-Saharan Africa, and OECD. Robust

standard errors reported in parentheses. Secondary enrollment ratio

used as instrument in IV estimation. Asterisks denote levels of

statistical significance: ** 95 percent; * 99 percent.

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