1
INTRODUCTION
This thesis aims at defining the influence and the role of institutions and political systems for development and economic growth in a country. Furthermore, it analyses the peculiarities of different political systems and their impact on the economy in order to assess if processes of development and paths of growth differ according to them. As a consequence, through this analysis it will be established if a specific political system is more suited to favour development compared to others, and if the same political-economic model can be applied indistinctly to every country to generate growth.
This dissertation bases its observations particularly on three sources: firstly, the theoretical remarks are based on the results of several analysis and studies that have been conducted by scholars and economists mostly during the 20th Century; secondly, it describes real examples of economic development happened recently in some countries in order to relate concrete events to the theoretical concepts; finally, the main theory is supported by the analysis of real data related to the level of GDP per capita and its projected growth for a hundred countries disclosed by the International Monetary Fund and the Freedom House.
More specifically, Chapter 1 describes the different types and processes of economic development, according to the theories of Karl Marx and Walt W. Rostow, who analysed empirically the stages of development and their effects on the economy and the society. They observed how the economic evolution of a country is almost always related to socio-cultural changes of the society. The chapter concludes with the analysis of the process of development occurred in the United Arab Emirates, which confirms that economic growth and socio-cultural changes mutually influence each other. The second chapter concentrates on the description of the main types of institutions which are most specifically tailored for enhancing economic development. According to Dani Rodrik – who outlined how these institutions should be – there are five types of market-supporting institutions, namely: property rights; regulatory institutions; institutions for macroeconomic stabilization;
institutions for social insurance; and institutions of conflict management. Institutions vary across countries because they are affected by the political ideologies of the ruling class and they are implemented according to the decision of the government. The influence of the government on economic development is closely analysed in the third chapter, which outlines how politicians influence institutions and the path of development according to their political ideology and the political system of the country they rule. More specifically, the analysis will focus on four political systems, namely: democracy, oligarchy, autocracy, and anarchy; and it will outline how and why each of them created a different path of economic development. The fourth chapter presents in a table the
2 data for a hundred nations – chosen randomly – ranked by the level of GDP per capita for the year 2018. Moreover, these countries are distinguished by their rate of growth, which is analysed in relation to three different variables: their level of GDP, the size of their population, and the level of freedom and political rights. The aim of this analysis is to compare and contrast the rates of growth of the countries in order to assess whether there is an association between a certain rate of growth and a specific political system. The fifth chapter concentrates on the debate about the existence of a unique economic model suited for stimulating growth both in underdeveloped and developing countries independently of their political system. Therefore, it presents the two main viewpoints on the issue in order to define which methodology could be applied to underdeveloped countries in order to induce economic growth and development.
According to the general framework of analysis developed in the thesis, given the major importance of good policies and reforms to enhance stability and security in a country, and given the fundamental role of institutions, underdeveloped and developing countries need the instauration of efficient institutions, good policies, and reforms to support socio-cultural changes that stimulate their process of growth. As a matter of fact, there is a strong and unavoidable interrelationship between economics and politics, which is the basis for the creation of every path of development. Assuming that paths of growth differ among various political systems and have peculiar features and factors, how could good and efficient institutions be implemented in underdeveloped countries in order to boost their economic growth?
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CHAPTER 1: THE PROCESS OF DEVELOPMENT
1. Political Revolutions and Stages of Development
Firstly, in order to understand the interrelationship between political institutions and economic behaviour, it is important to consider how the process of growth of a country takes place and originates by explaining its major causes and effects. However, this paper will concentrate more specifically on the analysis of the stages of development of a country and their correlation with the economic performance of that nation. The question about whether it is the evolution of the economy which determines the settlement of specific political institutions, or vice versa, has been of central interest for many economists and thinkers since the 19th Century. As a matter of fact, that period was characterized by various significant changes which included the second industrial revolution, the creation of new social classes with different objectives, the formation of new countries, and several political revolutions associated with numerous conflicts in almost every continent. All these changes and evolutions can be conceived to be the roots for the settlement of our modern society together with the advent of industrialization and capitalism in the following century. This course of events has been the starting point for a rapid process of growth in certain countries which nowadays are considered to be developed, and a similar process is happening in others which are categorized as “developing”.
As a ground for support to this study, we are going to cite the analysis of two economists who have an opposing view on the causes and effects of the process of economic development: Karl Marx and Walt Whitman Rostow. The comparison between these two theories will be useful for understanding the interrelation between the economy and the level of development of a country. These two are among the most known and respected theories of development because they provide a structured explanation about the ways in which the economy and the socio-political system of a country are influenced and dependent one from the other. Moreover, this analysis will highlight how the role of institutions has changed throughout history and the effect they have had for the economic development and growth.
Karl Marx’s theory was grounded on the philosophical theory called “Historical materialism”
and it was outlined in the book Das Kapital, published in 1867. Essentially, he defined five stages of development of human society which are responsible for determining the specific modes of production of a country. In particular, each main epoch of development is marked by a “socio- economic formation”. As a matter of fact, Marx thought that one specific economic structure determined a complementary social structure. In other words, a society changes and develops
4 according to the economic pattern of the country, and the most important concept which lays on the basis of this pyramid is the method of production. According to Friedrich Engels:
The materialist conception of history starts from the proposition that the production of the means to support human life and, next to production, the exchange of things produced, is the basis of all social structure;
[…] the final causes of all social changes and political revolutions are to be sought […] in changes in the mode of production and exchange. They are to be sought not in the philosophy, but in the economics of each particular epoch. (Engels 1892: 45).
The first stage outlined by Marx is called “Primitive Communism”, which can be found in tribal societies, where there is no division of labour between men and women and there are not social classes. The end of this stage is marked by contacts or conflicts between different populations, which lead to the creation of new social classes and therefore to a first basic structural division. The second stage is called “Slavery”, since it is characterized by the emerging of a large social class composed by slaves, who are controlled by their owners and masters. In these stages we also witness the evolution of the concept of private property. Here, land plays an essential role due to its importance for being the first and primary object for production and profit. Consequently, the following stage is
“Feudalism”, where the concept of land ownership has a central and essential role. As a matter of fact, it entails a further class distinction due to the emergence of the class of peasants, who control the lands owned by the landowners -the elite- and supervise the work of the slaves. The fourth stage of development is called “Capitalism”, which is distinguished by a new method of labour division.
As a matter of fact, this stage shows the transition from a horizontal division of labour to an indirect method of production. This implies that capitalists own both capital and the final product, while workers, who are exploited, do not own anything of the final goods they have produced. This condition has a negative effect on the workers, who feel they are exploited and alienated by their work. For Marx, the only consequence to this stage is a clash between the two classes of elite and workers, which will lead to a revolution and to the final collapse of Capitalism. Hence, for the German philosopher, the final stage of the process of development of a country is “Socialism”, where the factors of production, namely land and capital, are fully and wholly owned equally by all the society.
On the other hand, the American economist W. W. Rostow based his theory of the stages of development on a different assumption. Contrary to Marx, he believed that the different levels of development and growth were determined by changes and evolutions in the structure of the society.
In other words, the progressive emergence of new characters with different roles and aims would lead to economic and political changes envisaged to improve the productivity and profitability of a country. Rostow outlined his model in the second chapter of his book The Stages of Economic Growth: A non-communist manifesto (1960), where he defined five different stages. The first is called
5
“The traditional society” (1960: 4) because it represents the society at its basic economic level. Here, the society relies only on the goods of the primary sector, a subsistence agriculture, and hunting.
Social changes and class mobility are almost totally absent and, together with the technological backwardness, they are responsible for the country stagnation. In order to reach the upper level, which is called “The Preconditions for take-off”, the society must introduce a new character in the society, ready to take monetary risks and willing to enhance its production and profits. Therefore, we witness the beginning of individual social mobility, with the creation of an elite ready and able to invest their money in further technology and goods. These changes allow for a first technological progress and the creation of rudimental governmental structures and political institutions. As a consequence, the country starts developing and getting more productive, and it initiates a demand for raw materials from other consumers, which starts a simple and basic economic exchange. All these conditions are necessary for reaching the “The Take-off” stage, which is characterized by further technological progress and more productivity. Here, investments by the elite must rise in excess to the 10% of the national income, allowing for a major industrialization process. More important, a country must consolidate and increase the productivity of its leading sector in order for its market to raise more rapidly and to have access to higher amounts of capital. Common examples of leading sectors at this stage are the textile, apparel, and agricultural sectors. Moreover, we assist to changes in the composition of society with the emergence of a new class of workers; industrialization starts to spread and urbanization increases, with the consequent creation of new types of institutions. In addition, the transition to the “Take-off” stage is likely to be marked by some important events that lead to a revolution either in the political field or in the field of science and technology. According to Rostow (1960: 9) changes to the political structure of a country could be similar to the ones happened in USSR, East and West Germany, Japan, China and India. On the other hand, technological progress has led to innovations such as the ones during the Industrial Revolution started in the 18th Century in England. The fourth stage is called “The drive to Maturity”, and it is reached by a country only when its previous leading sector is replaced by other leading sectors, which allow the State to have a more complex and diversified economy and market. Hence, “the neo-technical industries supplement the paleo-technical industries” (Mallick: 2005). Furthermore, the consolidation of the process of industrialization amplifies the phenomenon of urban migration and brings to further changes in the structure of the society. As a matter of fact, in addition to the already existing figure of workers known as “blue-collars” we assist at the emergence of higher-rank workers called “white-collars”. Moreover, also the industrial leadership sees a switch from the figure of the entrepreneur to that of the manager.
Other important changes which take place at this stage are the implementation of better
6 infrastructures, transports, and public facilities for the citizens. The fifth and last stage of Rostow’s model, called “The age of high-mass consumption”, has been reached only by few countries today, namely: the USA, Western Europe, and Japan. It is characterized by an industrial based and centred economy, “where the leading sectors shift towards durable consumers’ goods and services” (Rostow, 1960: 10). The society is more various and almost fully urbanized, and the population has a decent amount of disposable income meant to be invested in high-value consumer goods (such as automobiles, telephones, computers). According to Rostow, at this stage, the country has the possibility to concentrate on various issues regarding military, foreign affairs, security and welfare of the citizens. Moreover, he states that the present institutions can “allocate increased resources to social welfare and security” in order to create a positive and optimal environment for the well-being of the citizens (1960: 11). He continued affirming that “the emergence of the welfare state is one manifestation of a society moving beyond technical maturity” (1960: 11). Finally, he affirmed that thanks to these measures a country can determine its uniqueness and its primacy, and its course of action will be strongly affected by its political structure, ideology, culture, values, and also its geographical position.
2. Criticism
Undoubtedly, the two theories have raised both arguments in favour on the one hand, and critics on the other. In general, both models are criticized because they do not build their conclusions on solid grounds. In particular, Rostow criticizes Marx because he does not stress his thesis on economic determinism, but he mostly focus on class struggles, falling profit rates, and consequent growing dissatisfaction among the working class, which will lead to the fall of capitalism. However, also Rostow’s theory has been deeply analysed through the years and many critics have attempted to highlight the weak points of his model. Firstly, he has been criticized for having created a model merely basing his assumptions on the study of the development process occurred in now developed countries in Europe and the United States. Therefore, critics argued that this model could not be generally applied to all other countries in Asia or Africa since the events outlined in the stages of the process have not been identified there.
Another point of objection was that the model is too “linear”, in the sense that it implies that development can occur only when a country follows the precise pattern of the model (Khan &
Marinaro, 2017). By consequence, a country should reach all the requirements outlined in the stages in the exact order displayed by Rostow. Actually, not all the countries who have reached a state of development have followed the process in the same way, but they may even have skipped some initial
7 stages. As an example, countries such as the United States of America, Canada, Australia or New Zealand did not start their development process since the first stage (Dabasish). As a matter of fact, since they all have been British colonies, they have derived the “preconditions to Take-off” not from the “Traditional society” (namely the first stage), but from their colonizer which was already advanced.
In addition, the theory has been criticized for being too general, in the sense that Rostow assumed that it would have been suited to be applicable for every country in the world, when in fact it is not possible due to the different features of the countries. Khan and Marinaro added that Rostow created his theory by considering the pattern of development of only nine European countries, in the period between the end of the Second World War and the Cold War (2017: 2302). They argued that these countries and other developing countries of different continents should not be treated in the same way due to their different characteristics in culture, politics, geography, population size and natural resources. As a matter of fact, all these features have influence on the development process of a country and they cannot be equal in the same size and manner between States. As a consequence, since developing states lack some of the conditions present in developed countries, they will not reach the stages of development in the same way. Consequently, it is reasonable to think that the kind of model proposed by Rostow, due to its general and linear approach, could not be the most precise and reliable tool for making any predictions or conclusions about the process of economic development for every country.
Finally, another major point of discussion of Rostow’s model regards the third stage: the
“Take-off”. Critics think that the American economist had not clearly differentiated the features of this stage from the previous one, creating confusion between the stages. Consequently, the demarcation is “blurred because the changes that take place in the transition stage also seem to take place in the take-off phase” (Thirlwall 2011: 107). However, it should be noted that Rostow’s model has not received only negative feedbacks, but it has also been positively valued because it offers a good overview on the important features needed to build a stable and long-lasting growth. In particular, great attention should be placed in analysing the requirements outlined by Rostow in the
“Take-off stage”, since they appear to be the launch pad for economic development. As a matter of fact, it is at this level that the fundamental transition from a rural to an industrial society takes places, leading the country to the crucial process of industrialization. However, these changes can occur only if a country has previously met all the preconditions required, hence a state must be stimulated to change, being it a technological innovation or a socio-political revolution. Both stimulus are linked to an innovation on the social front, because they encourage the emergence of a new class of
8 entrepreneurs (the elite) who will be able to respond to the new economic incentives by investing more capital and enhancing the production of goods for the creation of a larger market. Furthermore, Rostow stressed that these innovations will cause the establishment of a new political structure which will require a stable new form of government together with effective institutions.
3. Take-off and Political Revolutions
In the second chapter of his book Rostow emphasized the circular feature of the development process.
He affirmed that the innovations of the economic structure are all interrelated with changes in the social and political areas, and that the advent of a certain specific event involves and starts a process of evolution and changes. He precisely affirmed that “economic progress is a necessary condition for some other purpose” to happen, namely national power, general welfare, education, private and public profit (1961: 6). These developments would bring to changes that “suit the needs of modern economic activity”, including the necessary emergence of a new class of investors and entrepreneurs, which must be therefore supported and backed by precise institutions, such as banks and other monetary bodies for mobilizing capital. However, Rostow also asserted that at this stage the activity of innovation proceeds at a slow pace since the structure and values of the society are still grounded on old habits and customs likewise the political institutions. In order for this condition to change a country needs a social revolution to happen, in particular “the emergence to political power of a group prepared to regard the modernization of the economy as a serious, high-order political business”
(1961: 8). The willingness of the elite class of taking economic risks to invest, building new infrastructures and using new technologies - together with the emerging feelings of nationalism and colonial power - provided the ground for the creation of an effective centralized national State.
Rostow assumed these preconditions to be “almost universally a necessary condition for take-off”.
In his analysis, he mainly distinguished between two different procedures for a country to meet these preconditions. However, it is quite possible that there could be other processes because Rostow focused his study only on European or Western countries. Owing to the numerous differences between Eastern and Western countries on various levels, it would be wrong to assume that they all had similar processes of growth, and therefore Rostow’s development plan cannot be applied to any country. For this reason, at the moment, our attention should be focused only on European or colonized countries. Rostow placed the origins for this development process between the last years of the 17th Century and the beginning of the 18th Century in Europe. Among all the European countries Britain seemed to be the most inclined towards growth, since according to Rostow it was “favoured by geography, natural resources, trading possibilities, social and political structure” (1961: 6).
9 Therefore, he concluded that it was the first country to fully develop the preconditions for take-off, and it occurred in an endogenous way. However, he specified that in most of the countries, these processes generated thanks to exogenous factors introduced by more advanced societies. These invasions brought revolutionary and innovative changes, that modified the structure of the society and renewed the ideology and the sentiments of the population. These influences started a process of changes which was based on the population’s need and desire to reach a higher level of economic development which, as a consequence, would have allowed them to grow in other areas. However, Rostow added that even if a country had an economic evolution it did not imply inevitably that it would have grown also from a social and cultural point of view. In fact, he affirmed that in many cases the old traditional society persisted “with modern economic activities” initiated and conducted by their colonizers (1960: 7). This quote would suggest that social and cultural development are not a precondition to economic growth. On the other hand, what really is important and decisive for the economic system to evolve is a change in the political structure of the country, which would allow the creation of an “effective centralized national state”.
3.1 The Case of the United Arab Emirates
Finally, it can be affirmed that the most important preconditions for the starting of the “take-off”
phase are either an internal political revolution or a colonialist invasion, or both. This assumption could explain for example the development process of the countries of the Arabian Peninsula (Saudi Arabia, Yemen, Oman, UAE, Kuwait, Qatar, Bahrain) where there is a developed and rich economy together with a socio-cultural situation of underdevelopment and poverty. In the first half of the 19th Century, most of these countries started a process of economic growth initiated and sustained by the United Kingdom, their coloniser, which was centred on the exploitation of natural resources, specifically petroleum, discovered during the Thirties. Then, this period represented the first condition for the “take-off” stage, and it was followed by the other precondition envisaged by Rostow:
a political revolution. As a matter of fact, mostly during the Sixties and the beginning of the Seventies, the countries of this area undertook a process of political change which led them to obtain independence from the United Kingdom. More specifically, we could analyse the development process of the United Arab Emirates, which is now considered to be the most developed among the others of that geographical area. The territory of the actual United Arab Emirates started being attacked by the UK in the second half of the XIX Century and became a British protectorate in 1892.
In the Thirties, the discovering of oil reserves favoured the development and growth of the economic level of the country, with the consequent creation of a new elite class which marked a primary change
10 of the social structure. As it was envisaged by Rostow, this new situation and the influence of the colonisers started a process of evolution concerning the ideology and objectives of the local elite class. As a matter of fact, during the Fifties, seven emirates become more conscious about their political power, and decided to create the “Trucial State Council” - an organized and structured political institution - in order to obtain more economic and political freedom from their colonisers.
The UK remained a protectorate of the State until 1971, when it definitively withdrawn its troops.
This example shows that also the second assumption for the preconditions for “take-off” is true: a political revolution following a colonial invasion. This situation allowed for the creation of new political institutions, a centralised and united State and the birth of a strong elite class formed by the 7 emirates. All these circumstances have been essential for the economic growth of the country.
Today the UAE is a federation of absolute monarchies, with a strong political structure and an increasing economy. However, given the different levels of development between the economic, political and cultural areas it is difficult to judge which of Rostow’s stages the country belongs to. As a matter of fact, the UAE has not started the development process in an autonomous way, but it has been influenced and started by the coloniser. In this way, the Arab State did not develop an agricultural industry at the beginning, which is typical of the first stage, and which Rostow assumed to be fundamental for an effective and long-lasting process of development. He believed that a large and strong agricultural production is the first condition for a country to build and create a solid economy, since it can be used in the market and for the population. Therefore, the UAE has begun its development process already from the second stage, where it has met all the preconditions for “take- off”: the rise of a new elite class ready to invest in further technology and goods, the creation of simple governmental institutions, and the consolidation of a leading sector of the economy. By consequence, the State has currently reached the third stage, but considering its actual features and comparing them to those envisaged by Rostow, it can be assumed that the UAE is in a stalemate concerning economic progress. The American economist sustained that in order to have a successful
“take-off” ‘the revolutionary changes in agricultural productivity are an essential condition’ for a country. Nevertheless, the UAE is in an opposite situation since it remains extremely reliant on oil production and is not placing any investment for the increase and development of technology in agriculture. As a consequence, it could be assumed that since the UAE lacks an essential component for growth, its economy will not change, and the overall condition of the country will not improve in the long run. On the contrary, data shows a different situation: the GDP per capita of the country actually amounts at 40782.40 USD and it is projected to trend around 43900.00 USD in 2020, placing the country among the best 10 in the world (Trading Economics 2019). In addition, The HDI of the
11 country amounted to 0.863 in the 2018 Human Development Report issued by the UNDP, placing the State at the 34th place among the “Very high human development” countries. The economic strength seems to rely on a “cautious political control” and on a wise equilibrium between the numerous people who have a position of authority in the State (Manzi 2013). This equilibrium is kept stable by the efficiency of the political structure of the country and the quality of its institutions. The United Arab Emirates is a Federal absolute monarchy composed by seven States, whose president is elected every five years by the Federal National Council which is formed by the emirates of the seven States. The political line is very rigid, and the government adopts strict rules in order to keep the population under control to avoid any potential insurrection or political revolution. This approach is guaranteeing both political stability and economic efficiency to the country, which make it highly attractive to foreign investors and Western countries. The most important measures concerned an increase of investments in technology, the start of a process of economic diversification towards the non-oil sector, and an empowering of the fiscal policy. Moreover, the Federal National Council is recently showing an increasing attention to social themes (education, health), socio-economic issues (strengthening of the small-medium enterprises), and the empowerment of women. However, despite these important innovations, even if the oil market is more and more profitable and the overall economy is always increasing and developing, the same cannot be said for the condition of the society and the population.
In fact, the Freedom House measured the country’s level of democracy, political rights and civil liberties and it resulted that the State is not politically free. Moreover, they judged that “the civil liberties of both citizens and noncitizens, who make up an overwhelming majority of the population, are subject to significant restrictions.” (Freedom House 2019).
In conclusion, this analysis has depicted a country with an autocratic political system, almost absent political freedom and rigid institutions together with a strong growing economy, increasing investments, a developing market and one of the highest GDP per capita in the world. According to the experts, the economic strength of UAE and the uniqueness of its process of growth seem to rely on the effectiveness and the functioning of its institutions. Therefore, this assumption induces us to focus the next chapter on the analysis of institutions, in order to understand the role they play in the development process and the various ways they can influence the economic conduct of a country.
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CHAPTER 2: INSTITUTIONS
1. The Origins of Institutions
The previous case has highlighted the importance of having efficient institutions in order to obtain economic growth and development. This belief is widely accepted throughout the numerous economists and political experts, and it has become a cornerstone in the theories of development economics. One of the major supporters of this view was the American economist Douglass C. North, who dedicated most of his career studying the positive impact of institutions – especially well- developed property rights – on economic growth and gave birth to the field of study known as “new institutional economics”. He affirmed that institutions “are the rules of the game in a society or, more formally, are the humanly devised constrains that shape human behaviour” (North 1990: 3). In the same work, he added that since institutions promote for changes and development in the social, political, and economic areas they are the stimulus to the evolution of societies. By consequence, by analysing the institutional change of a country we could explain the historical progress and change of that same State. Therefore, it can be noted that institutions play a central role not only for economic evolution, but also for the development of the society and its culture.
Institutions are highly interconnected with human behaviour and everyday life transactions and interactions, as a matter of fact they originated precisely for facilitate relations between people.
“They are a guide to human interaction” and “reduce uncertainty by providing a structure to everyday life” (1990: 3-4). According to Rostow (1960), the first types of institutions emerged in a country during the stage called “the preconditions for take-off” due to the need of rules to control market transactions. At this stage, the internal production of a country starts increasing, and this induces the expansion of the market and the broadening of contractual transactions. Therefore, the creation of institutions originated from the necessity of merchants and traders to establish common rules for economic activities and social relations. However, it has to be noted that these institutions were still linked to the old social structure and values, and they started to develop only during the following stage: “the take-off”. This stage is characterized by rises in production, evolutions in technology, greater investments and social changes, which contribute to the spread of the economic framework and the creation of an international market. As a consequence, the developing countries witnessed the creation of more efficient institutions in order to “provide incentives and also structure economic, political and social activity” (North 2003: 1).
14 Moreover, the origins and development of institutions is not homogeneous, but they evolve and change depending on different and various factors. North (1990: 4) affirmed that institutions can either evolve autonomously over time – giving the “common law” as an example – or they can be created by men – such as the “United State Constitution”. He added that they can also be formal – such as rules created by human beings – or informal – for example “conventions and codes of behaviour”. Despite these differences, the one thing they have in common is the purpose for which they were created or originated: to support the growth process and to facilitate human living. Another scholar who tried to explain the process of evolution and settlement of institutions was the Turkish- born American economist K. Daron Acemoglu. Together with Johnson and Robinson he outlined a theory to explain the causes for the different levels of development of institutions, which was explained in their famous paper The Colonial Origins of Comparative Development: An Empirical Investigation (2001). They believed that with this analysis they would have been able to finally explain the reasons why certain countries are less developed than others. Their study concentrated on
“institutional differences among countries colonized by Europeans” (2001: 1370). They specify that this includes not only the countries that have been directly controlled by the colonisers – hence, Sub- Saharan Africa – but also those where the Europeans brought their influence. On account of that, they tried to find an “exogenous cause of variations in institutions”, namely “the way in which colonizers settled in countries in the seventeenth and eighteenth centuries” (Thirlwall 2011: 122). As a matter of fact, their theory was based on a measure of colonization, determined by the mortality rates of the colonisers. In their opinion, this would have influenced the degree of settlement, which in turn would have determined the type of early institution and consequently its actual evolution. In particular, they outlined three premises to support their theory: firstly, they distinguished between two types of colonization policies which originated different types of institutions. In the first type, Europeans did not impose their institutions because their main goal was to exploit all the resources of the colony in order to export their goods: for this reason these countries are referred as “extractive states”. On the other hand, in other countries – such as Australia, New Zealand, Canada and the USA – Europeans settled with their institutions, which they imposed on their colonies. Secondly, they affirmed that the introduction of European institutions was influenced by the “feasibility of settlement”. They stated that in those countries where the incidence of mortality and disease was higher, the Europeans were not able to spread their institutions. Lastly, they assumed that institutions created and settled by Europeans in the colonial states persisted also after their independence and could have evolved over time.
15 Undoubtedly, Acemoglu’s study has been regarded as one of the major institutional theories of economic development for the validity of its points and of the premises. However, it has also received critics regarding its incompleteness and the absence of clarifications on some points. First of all, Dzionek-Kozłowska and Matera criticised Acemoglu for having rejected completely the
“culture hypothesis” (2016: 2), denying therefore the importance of the role of cultural differences in customs, habits, and traditions for the evolution of institutions. In fact, the two scholars sustain that there is a strong relation between those factors and that the emergence of institutions is dependent of cultural influences. They also affirmed that Acemoglu and Robinson tried to sustain their thesis by explaining that “both political and economic institutions are established as a result of collective choices made by members of society.” (2016: 7). Therefore, their main assumption is based on the idea that since economic institutions, like political ones, are based on collective choices, “the distribution of political power in society is the key determinant of their evolutions” (Acemoglu 2009:
391-392). However, with this affirmation, Acemoglu takes into consideration only “formal”
institutions, and fails to consider also “informal institutions”, hence he finds no “close correspondence between the de facto political power and the informal, culture-embedded constraints.” (2016: 5).
Moreover, Dzionek-Kozłowska and Matera criticized the American economist for affirming that culture, values, beliefs and moral rules are beyond the control of people. In fact, they prove the contrary by taking as an example the situation of totalitarian states, where “narrow elites which decide on the shape of political and economic institutions” have the power to “wield influence or even put under total control the realm of culture, just like the other spheres of social life” (2016: 9-10).
Furthermore, Acemoglu and Robinson not only dismiss the importance of culture, but they also deny the role of geography in the economic evolution of countries. Another economist sceptical about the role of culture in the development process of countries was Dany Rodrik, who affirmed that the only determinant for growth is the establishment of effective institutions (2011: 124). However, later on in his studies (2004), he accepted the idea that “geography has a strong indirect effect through institutions by influencing their quality”. As a matter of fact, at the same time, there are scholars who believe in the importance of geography for the development of institutions. Among these, the American economist Jeffrey Sachs conducted various studies for assessing the extent to which institutional quality and therefore economic development are affected by other variables, apart from institutional quality. In his studies he found out that economic growth in underdeveloped countries is held back not only by institutional backwardness, but also because of lack of resources and technologies. As a demonstration, he studied the impact of the malaria disease in Africa for explaining economic underdevelopment in the poorest countries. He thought that “disease, geographical
16 isolation, low technological productivity, and resource limitations” were the fundamental causes for poverty in those countries, and that developed countries should help them with interventions and donations. According to Sachs, the role of institutions and good governance in this context is essential for making those interventions effective, and consequently for allowing underdeveloped countries to grow economically.
2. The Types of Institutions
Currently, the debate concerning the role of geography for economic development and its relation with institutions is still affecting the studies of various economists, because there is not a final and clear answer yet. Despite these uncertainties, it cannot be denied that the two influence each other on different levels. As a matter of fact, territorial adversities impede technological growth and infrastructure efficiency. These are fundamental for a country to develop economically because they allow for market transactions and foreign trade to take place. Citing Sachs (2003: 39) nowadays “in an environment in which capital and people can move around with relative ease, the disadvantages of adverse geography — physical isolation, endemic disease, or other local problems (such as poor soil fertility) — are magnified”. Notwithstanding the different opinions about the way institutions have originated and developed, the reasons why they have been created or emerged are almost entirely accepted. In developing countries, institutions have originated for facilitating the economy and for allowing market transactions to occur easily in order to lower the costs. In particular, Dani Rodrik defined five main types of market-supporting institutions aimed to favour economic growth. His theory is based on the assumption of the Hungarian economist Karl Polanyi, who believed that markets are sustainable only if they are combined with social and political institutions. Rodrik claimed (2001: 2) that these institutions are fundamental for the survival of the market, since they provide it with three essential functions. “They regulate, stabilize, and legitimate [emphasis added]
market outcomes” in order to bring them “into conformity with a society’s preferences regarding the distribution of risks and rewards.” (2001: 2). Moreover, he specified that these institutions do not exist at a global level: they cannot be convergent or similar because “values and norms obviously differ across countries.” (2001: 3). As a matter of fact, the way institutions evolve is shaped by humans’ cultural heritage: a set of rules, norms, beliefs and experiences (North 2003). Furthermore, Rodrik added that these economic institutions derive from previous political institutions: humans have evolved “a political structure that in turn puts in place an economic structure that shapes how that society works” (2001: 3). These studies have showed how economic institutions and the overall economy are influenced and shaped by the political institutions of a country, which in turn depend on the cultural features and traditions of the society. On this basis, it could be affirmed that, to a certain
17 extent, one of the reasons why economies differ among countries is related to the culture and customs of a population. As a matter of fact, not all the five types of market-supporting institutions have emerged equally in every country since their origin depends on the political opinion and economic view of the ruling class. In particular, according to Acemoglu and Robinson “Institutions can differ between societies because of their formal methods of collective decision-making (democracy versus dictatorship) or because of their economic institutions (security of property rights, entry barriers, the set of contracts available to businessmen).” (2008: 2). Furthermore, they add that “the economic institutions of a society depend on the nature of political institutions and the distribution of political power in society.”
Dani Rodrik (2000: 5) outlined five types of market-supporting institutions: “property rights;
regulatory institutions; institutions for macroeconomic stabilization; institutions for social insurance;
and institutions of conflict management”. Property rights (and legally binding contracts) can be defined to be market-creating institutions (Thirlwall 2011), because they are at the basis of the today’s developed economies: they “have been a key element in the rise of the West and the onset of modern economic growth”. (Rodrik 2000). They are essential for ensuring to entrepreneurs the control over their assets, who are then encouraged to accumulate and innovate their investments. Rodrik placed greater importance on control rights since they can favour entrepreneurial activity even in the absence of property rights. Differently from property rights, they “are upheld by a combination of legislation, private enforcement, and custom and tradition.” On the other hand, regulatory institutions are market- regulating institutions because they fight fraudulency or anti-competitive behaviours by “regulating conduct in goods, services, labour, asset, and financial markets”. (2000: 7). The American economist pointed out that the need for these kinds of institutions is much greater in those countries with a free market and financial liberalization. Moreover, Rodrik highlighted the importance of providing other institutions - such as anti-trust, financial supervision, securities regulation – especially in developing countries, where market failures are more numerous and government interventions are more likely to happen. In addition, there are other types of institutions for macroeconomic stabilization such as fiscal and monetary institutions, for example the central bank, created to guard against financial crises and the instability of markets. A good combination of a strong banking system and an effective fiscal policy is essential to ensure macroeconomic stability. Lastly, the institutions for market legitimization consist of social insurance institutions and institutions of conflict management. Rodrik affirmed that
“social insurance legitimizes a market economy because it renders it compatible with social stability and social cohesion.” (2000: 11) and he stressed on the importance of this kind of institutions for creating a positive economic environment. He gave as an example the situation of some countries in
18 Latin America, where the negligence for these institutions caused economic instability, large social inequalities, and volatile outcomes. Particularly in the agricultural sector where risks are higher, good economic reforms must be supported by social insurance against unemployment, crop failures, and price fluctuation. However, these institutions are essential in general for the wellbeing of the whole economy since social instability and conflicts are negative for growth and development. As a matter of fact, the last type of institutions is aimed at managing conflicts between different social groups.
Rodrik highlighted that coordinating social factions is essential for having a healthy society and therefore a developed economy. He gave different examples of institutions which coordinate and control for these failures, such as: “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” (2000: 12).
These 5 types of non-market institutions are “complementary elements” that are all equally important and essential for allowing a market to perform regularly and efficiently. As a matter of fact, Rodrik affirmed that in order for a market to function well, the institutions have to be integrated into the economy, which must be “a mix of state and market, laissez faire and intervention” (2000: 13).
However, the vast majority of countries in the world does not have all five institutions at the same time. In this respect, Rodrik tried to outline the reasons why they cannot be present in every country by answering to the question of how “good” institutions are acquired. He stressed on the point that it is not correct to believe in the idea that “a specific type of institution is the only type that is compatible with a well-functioning market economy.” (2000: 14). On the contrary, he suggested that institutions originate and develop differently in every country since they depend on the “local needs and capabilities”, the cultural features of the society, and its political leanings. As a consequence, every government should focus on its requirements, it should set its main goals and objectives in order to create and implement the institutions more suitable for its economy.
Rodrik identified two modes in which institutions can be acquired, both in a passive and active way. The first modality consists in “importing a blueprint from the more advanced economies”;
therefore, it simply implies to adopt an already existing structure of a market economy. However, Rodrik claimed that this type of institutions is useless for the country which imports them, because they are suited to meet the needs of the country that has created them at the beginning. These imported blueprints are therefore inappropriate and ineffective. On the contrary, the importing country should develop locally its own set of institutions “relying on hands-on experience, local knowledge, and experimentation” (2000: 15). The second modality is focused exactly on “local knowledge”, hence it implies that a country develops its own institutions by considering its own features and needs. Despite
19 Rodrik judged the first mode to be almost entirely inappropriate, he did not esteem the second one to be positive by any measure. As a matter of fact, he stated that even in the unlikely event that an imported blueprint meets the local conditions of the importing country, it still requires high “domestic expertise” in order to be successfully implemented. Rodrik firmly supported the theory of gradualism/experimentalism for institution building and development, and he favoured it to a non- gradual mode he defined as “shock therapy” (2000: 17). Anyway, he also highlighted the disadvantages of experimentalism, noting that it is costly to build new institutions from scratch, both in terms of time and resources.
All things considered, it can be noted that the two modes of institutions acquisition have both positive and negative features. As a consequence, for developing countries there is not a better and more efficient modality, politicians should make the choice mainly by asking themselves which are the goals and objectives they want their country to achieve. In order to answer to these questions focusing on local knowledge is the best solution: because institutional development and market growth require a “process of discovery about local needs and capabilities” (2000: 19). The local- knowledge approach requires mechanisms for eliciting local information, such as participatory political institutions. These are defined to be “meta-institutions” helpful to aggregate local knowledge and consequently essential to build effective and better institutions. Moreover, Rodrik conceded that there are also some non-democratic countries which have developed and built good institutions by using devices alternative to political participation. However, they remain an exception since he has no doubt in affirming that the best way to obtain higher-quality growth is through participatory political regimes.
3. The Effects of Strong and Weak Institutions
The debate concerning the modality to create and develop better and more efficient institutions has not led to a final answer; therefore, economists are still studying these processes to find a conclusion.
Despite these uncertainties, several economists and scholars agreed that institutions play a central role for the economic status of a country. They affirmed that effective institutions have a positive effect on economic growth and the development of the market. As a matter of fact, according to Acemoglu et al. (2003) institutions are the main determinant to understand economic differences between developed and underdeveloped countries. In their studies they proved that societies with weak institutions are unable to deal with their own economic and political shocks, and that this inability led them to “state failures” (civil wars, riots, violence). This happens because weak institutions are not able to control the leading class and to constrain their power. As a consequence,
20 the ruling class takes advantages of its position by imposing constraining policies to the population.
Obviously, this situation pushes various groups of the society to fight the elite in order to stop their activity and to gain power for themselves, and this happens almost every time through violence and coups. Nevertheless, Acemoglu noted that institutions which control the power of the executive are only one measure of institutions. It could be possible that even if a country has effective constraints on their ruling class, it may however suffer from corruption or other weaknesses for other reasons.
Therefore, he tried to widen his area of study by analysing various types of institutions, he referred to as “social arrangements” [emphasis in the original]. This “cluster” included institutions which provided for “constitutional and social limits on politicians’ and elites’ power, the rule of law, provisions for mediating social cleavages, strong property rights enforcement, a minimum amount of equal opportunity and relatively broad-based access to education, etc.” (2003: 52). He sustained that the quality of institutions is the cause for differences in volatility, crises, and growth in countries, which accentuated in the post-war period. In order to discover the reason why institutions have developed differently among countries, he tried to analyse their process of evolution. Finally, he discovered the existence of “a strong and robust relationship between the historically determined component of post-war institutions and volatility (as well as severity of economic crises and economic growth)” (2003: 51). As a matter of fact, the developing countries where Europeans only exploited the resources and did not settle – referred to as “extractive States” – developed the worse institutions and were “much more likely to experience high volatility and severe economic crises” (2003: 51).
These drawbacks originated because they were not able to put constraints on the State power and to oppose the authoritarian regimes set-up by colonisers. These conditions facilitated the Europeans’
activity: they could easily gain the control over the society and extract their resources at the maximum.
Besides the importance of the role played by institutions for constraining the power of the elite, Acemoglu stressed also on the fundamental role of property rights and the rule of law. These institutions are essential for encouraging investments from the entrepreneurs and increasing the value of the market of a country. Obviously, Europeans did not introduce these institutions in the “extractive states”, which consequently have witnessed a high rate of corruption and the enforcement of poor property rights and contracts. On the contrary, those colonies which developed “institutions of private property” were also able to put effective constraints on the elite and politicians. In this way, they set up institutions for protecting their own rights and safeguarding their freedoms. Moreover, in order to guarantee the right protection for investors and creditors, a country must develop an effective legal system characterized by courts and regulation. These assumptions highlighted the importance of the
21 role of institutions together with means of de jure protection. The enforcement of these “de jure rights” is exactly determined by a broad range of institutions including “property rights protection for a broader cross-section of society, constraints on politicians and elites, arrangements to manage social divisions and ensure political stability, and the ‘rule le of law’” (2003: 100). Their interrelation is essential for avoiding volatility and for improving economic performance.
In addition, Acemoglu highlighted the fact that these institutions have a positive effect, not only for the economy of a country, but also on its society. Undoubtedly, the two areas influence one another, in the sense that if the economy of a country is positive, it is likely that the population as well is quite wealthy. On the contrary, a difficult economic situation and an ineffective market would disincentivize entrepreneurs and investors. Moreover, the political instability linked to the financial underdevelopment would push the population in performing riots and acting violently. By consequence, the institutions which constraints the power of the elite and those for the enforcement of property rights have a primary role for avoiding this situation. Politicians should be aware of the importance of providing equal opportunities for all its citizens, since this would favour not only the general welfare of the country, but also its economic situation. As a matter of fact, a positive environment and an increasing economy would incentivize entrepreneurs to invest their money in more technology and encourage citizens in participating productively for the society. Equal opportunities are created by redistributing income equally from the richer minority to rest of the population. A richer lower and middle classes would be encouraged to increase their consumption and investing their money, having positive outcomes on the overall economy of the country.
Thanks to this study, Acemoglu and his collaborators have been able to demonstrate that weak institutions cause volatility, instability, underdevelopment and social inequalities. They proved that institutions have a role on political power and policy making. As a matter of fact, in every country, economic institutions are interrelated with politics and they influence one another. Basically, it is inconceivable to analyse the economic situation of a country without taking into account its political system and its social structure. Nevertheless, Acemoglu and his collaborators concluded by declaring that their results did not allow them to understand the exact mechanism “via which institutional weaknesses translate into economic instability”, hinting that more research still needs to be done (2003: 108).
4. Measuring the Quality of Institutions
In the recent years, many scholars have tried to assess indexes and measures to calculate the quality of institutions and their level of development. Their analysis also offered an overall picture of the
22 economic status of the countries, due to the interrelation between institutions, policy and their impact on the market. In this field of research, there are seven important studies which are peculiar because of their novelty and for the variety of the features they cover. However, it should be noted that there are many difficulties in determining exactly which features should have the institutions to be efficient.
For example, it is difficult to distinguish the level of influence of every single institution, since there are many variables and because they are highly interrelated with one another. Moreover, it must be specified that these measures are ordinal, hence they do not indicate the “magnitude” that institutional variables have on certain areas, but they simply rank the countries from the most to the least developed.
The first range of measures has been developed by the economists Daniel Kaufmann, Aart Kraay, and Pablo Zoido-Lobatón for the World Bank. The aim of their research was to “provide empirical evidence” of the strong relation between better governance and better development outcomes, and the influence that the first has to the other. The scholars based their analysis in a cross- section of more than 150 countries, compiling a database with more than 300 governance indicators taken from various sources. Finally, they developed six aggregate governance indicators related to six governance concepts: “voice and accountability, political instability and violence, government effectiveness, regulatory burden, rule of law, and graft.” (1999). Kaufmann and his collaborators define governance to be “the traditions and institutions by which authority in a country is exercised”
(1999: 1). Their attention therefore focused on the subjective perceptions that the “interested parties”
– citizens, foreign investors, entrepreneurs - have concerning the quality of their government of a certain country. Moreover, they also highlighted the strength of their method of study: they sustained the effectiveness of their data despite the fact that these are subjective. In fact, they sustained that in certain cases – such as for measuring corruption - this is the only way to obtain data. Moreover, they affirmed that this kind of measures allowed to have a much larger set of countries for comparisons.
More specifically, the six measures are related to three main aspects: the method of selection of the ruling class; the capacity of the State to implement effective policies; the respect of the rules of common interaction by the citizens and the State. The first area of study is covered by two clusters of aggregate governance indicators, namely: “Voice and Accountability” and “Political Instability and Violence”. The first group included various aspects of the political system, civil liberties, and political rights. It indicated if the citizens were able to choose freely for their government, and the level of the independence of the media. The second cluster was built upon the perception of citizens about the likelihood that the government could be overthrown by violent or illegal means. For a country it is important to guarantee political freedoms and rights to the citizens in order for them to
23 have an active and positive relation with the ruling class. A peaceful situation would allow the politician to concentrate on other matters to the benefit of the population – such as financial policies for the improvement of the economy. The second area of study is covered by other two clusters: the first, “Government Effectiveness”, groups together many aspects related to the quality of the government and the competence of its functionaries. In particular, it focuses on the ability of politicians to develop effective policies. The second cluster was named “Regulatory Burden” because it indicates the extent to which market-unfriendly policies and excessive regulation slow down economic growth. The last two clusters included in the third area of study are: the “Rule of Law” and
“Graft”. The first indicator measures the quality and effectiveness of the rules which govern economic and social interactions between the citizens and the State. The final cluster measures the perceptions about the presence of corruption in a country. Kaufmann considered it to be a failure of governance because it is a “lack of respect of both the corrupter […] and the corrupted […] for the rules which govern their interaction” (1999: 8). This behaviour entails an abuse of political and public power for private gain, and it is proved to be unfavourable for economic growth and development.”
The results obtained by the three economists through their model showed that the six indicators have a strong positive association with three development outcomes: “per capita incomes, infant mortality, and adult literacy” (1999: 12). However, these simple findings cannot be considered as the rule, since there could be any possibility of errors due to the fact that governance cannot be precisely measured. On the contrary, it might be possible to define a list of the countries with the highest or lowest level of governance. As a matter of fact, it is not “randomly distributed”, but it
“requires time and resources to develop”; in this sense “richer countries are more likely to enjoy good governance” (1999: 13). Furthermore, they stated that governance depends on the political and social history of a country. Therefore, in those countries which have suffered the colonization process, the governance structure is strictly related to the influence of European colonisers’ institutions.
Undoubtedly, these outcomes have proved to be very useful for further studies in this field and have provided new evidence that governance matters for economic development: good governance leads to positive growth.
The second study which has contributed to the analysis of the quality of institutions and their relation with economic growth has been developed by Stephen Knack and Philip Keefer in 1995.
They believed that secure property and contractual rights were essential for encouraging investment and specialization. Their analysis was based on the institutional data provided by two private international investment risk services, namely: the International Country Risk Guide (ICRG) in 1972, and the Business Environmental Risk Intelligence (BERI) in 1982. The variables used from the ICGR
24 concerned: measures of “Expropriation Risk”; “Rule of Law”; Repudiation of Contracts by Government”; “Repudiation”; “Corruption in Government”; “Quality of Bureaucracy”. The first three refer to security of property rights and contract enforcement, which are important factors for investors and entrepreneurs. As a matter of fact, those countries which rate low on these variables are likely to have insufficient physical and human capital investments, because investors are not encouraged to take risks. The lack of rules aimed at regulating the enforcement of contracts will induce “impersonal exchanges” with self-enforced contracts (1995: 211). The last three ICGR variables concern government credibility, efficiency, and quality. These features are measured by considering the services provided, the level of corruption, the extent of the rent-seeking behaviour.
Those countries which lack “procedural clarity or technical competence” are prone to award contract, licences, and rights based on illegal criteria. This distorted situation will lead to an inefficient market, a reduction of trade, less capital investments and foreign technology. On the other hand, the BERI measures used by Knack and Keefer are only four: “Contract Enforceability”, “Infrastructure Quality”, “Nationalization Potential”, “Bureaucratic Delays”. The two economists reported a strong correlation between the two indexes, and obtained similar results from both: high values of the two indexes indicated a better condition for investments to take place. Moreover, they developed three conclusions: the first one concerned the essentiality of institutions that protect property rights for economic growth and investments. Furthermore, they discovered that “the effect of institutions on growth persists even after controlling for investments”, implying that the security of property rights affects both the quality of investments and the efficiency of the allocated inputs. Secondly, they assumed that conditional convergence occurs when institutions are controlled for. Finally, they sustained that indirect indexes such as the “political violence and the Gastil political and civil liberties indicators” are ineffective and insufficient for evaluating the quality and influence of institutions that protect property rights. As a matter of fact, they stated that is not correct to use the variables of revolutions and coups, and assassinations to evaluate the conditions for investment. They sustained that it is a mistake to believe that political instability and violence is directly related and linked to bad conditions of investment. On the one hand, they admitted that during periods of political instability, which are “triggered by non-constitutional events”, institutions are weaker and therefore entrepreneurs are not encouraged to invest their money in order not to take any risks (1995: 209). On the other hand, Keefer and Knack highlighted that this variable reflects only partially the variation in the mechanisms of property and contractual rights protection. As a matter of fact, this proxy considers only non-constitutional political events, entailing that “the effects of leadership tenure on property rights” depend only if they are related to “expectations of unconstitutional replacement”. (1995: 209).
