State Failure in Developing Countries and Strategies of Institutional Reform By: Mushtaq H. Khan Department of Economics, SOAS, University of London 6/16/20101Presented By: Mohamed A. Salem

What is the role of the government? Service provider: To provide law and order, stable property rights, key public goods and welfares re-distributions. OR Social transformer: From traditional production systems to a capitalist economy. 6/16/20102Presented By: Mohamed A. Salem

Service-Delivery view The three theoretical component of liberal market economy: 1. Efficient markets are rent-free and have stable property rights. 2. Rent-Seeking creates rent and destabilizes property rights. 3. The absence of democracy and a weak bureaucracy allows rent-seeking to continue. 6/16/20103Presented By: Mohamed A. Salem

Failure 6/16/20104Presented By: Mohamed A. Salem

How can we deal with this failure? Institutional (governance) reforms:  Economic reforms. Rent-free markets  Political reforms. Democracy-Decentralization-Civil society  Institutional reforms. Right size – Judiciary independence – Raise salaries + Fighting corruption 6/16/20105Presented By: Mohamed A. Salem

6/16/20106Presented By: Mohamed A. Salem

6/16/20107Presented By: Mohamed A. Salem

The social transformation state view Social and Economic Change. The economic power and violence potential of the state is inevitably deployed for better or for worse. The state is an instrument in the hands of contending classes, groups and political entrepreneurs each attempting to capture resources and steer the transformation in specific directions 6/16/20108Presented By: Mohamed A. Salem

Economic facts in capitalist countries Much of the resources for running the political system comes from the capitalist sector. The dominance of the capitalist sector means that the immediate welfare of most people, even if they are not capitalists, depends on the health of the capitalist sector. 6/16/20109Presented By: Mohamed A. Salem

Failure The absence of a dominating feedback loop from the performance of the capitalist sector to the political process allows a much greater range of variation in policies and institutions, and makes it possible for there to be sustained state failure in ensuring a dynamic transformation. 6/16/201010Presented By: Mohamed A. Salem

6/16/201011Presented By: Mohamed A. Salem

State intervention – Social Transformation A tax system that is efficient in raising resources for delivery of democratically agreed upon public goods Well-defined rights would help efficient re- allocations only if transaction costs were low. The outcomes of transfer and destruction of property rights depend not on the stability of prior property rights structures but on who is capturing resources and the institutional structure imposing discipline. 6/16/201012Presented By: Mohamed A. Salem

The stability which distinguishes high- growth states is not a stability of property rights but rather a more subtle stability of commitment to growth, which means that dynamic entrepreneurs could have stable expectations that if they remained dynamic, they were unlikely to be touched. 6/16/201013Presented By: Mohamed A. Salem

South Korea Maintaining sufficient discipline to ensure that the transfer of wealth process was not entirely captured by inefficient groups. The conditional subsidy scheme for learning technologies could have had high social costs if as a result many plants had to be scrapped. But in practice, not only subsidies, but plants too were re-allocated across industrial groups when failure appeared likely. The state was involved in frequent corporate restructurings that re-allocated plants, using its financial muscle in the banking sector to get its way 6/16/201014Presented By: Mohamed A. Salem

China Property rights are not well-defined in China but its growth is much better than all countries. China was able to re-allocate rights over land and to control internal population movements that allowed it to set up such massive export zones (Changing objective) in the first place. 6/16/201015Presented By: Mohamed A. Salem

Dynamic State !? Managing growth-enhancing rents. Institutions for managing information rents. Schumpeterian rents are essential for innovation. Creating learning rents to enhance the usage of advanced technologies. Destroy growth-reducing rents. competition policy. regulation. 6/16/201016Presented By: Mohamed A. Salem

Organizing ring-fenced transfers to maintain political stability. In reality, transfers often cause serious economic damage if the only way in which fragmented groups can capture resources is by creating or capturing a large number of uncoordinated value- reducing rents, like inferior public good provision or by capturing subsidies for industrial learners. 6/16/201017Presented By: Mohamed A. Salem

What is required? Set of institutions with the regulatory capacity to make distinctions between different kinds of rents and with the political capacity to manage these rents to generate growth and rapid transformation. 6/16/201018Presented By: Mohamed A. Salem

Transformation States 6/16/201019Presented By: Mohamed A. Salem

Other dimensions of state failure during the transformation. The Effectiveness of Institutional Enforcement. Fail to effectively enforce industrial policy regimes. Fail to enforce any growth-generating institution, including property rights for potentially productive users. Effective enforcement requires both institutional capacity and a compatibility of institutions with the interests of powerful social groups. 6/16/201020Presented By: Mohamed A. Salem

institutional capacity institutional capacity means the ability of the state to do (positive) things. It requires: 1. Staffed court system. 2. Effective political capacity to: Neutralize unproductive groups. Creation of political organization of productive groups. 6/16/201021Presented By: Mohamed A. Salem

Compatibility of institutions The need to construct a compatible package of institutional reform and political restructuring of organized power which may allow better enforcement of a dynamic transformation strategy in the future. The lesson is that in poorly performing countries, much more deliberate steps have to be taken to construct compatible packages of institutions and political settlements to achieve even second-best transformation success. 6/16/201022Presented By: Mohamed A. Salem

The Costs of Enforcement The enforcement cost is the aggregate rent-seeking cost of running particular institutions including: The costs of lobbying, The resources spent in economic and political corruption, The costs of all types of “political” activity from maintaining patron-client networks to contributions to political parties, The policing costs of the state, All expenditures and activities that aim to protect or change institutions. 6/16/201023Presented By: Mohamed A. Salem

The Location of State Failure 6/16/201024Presented By: Mohamed A. Salem

Critical success factors for growth- enhancing institutional transition 1. Political will and democracy, 2. Wisdom of leaders, 3. The institutions through which the change is organized, and 4. Distribution of power between groups. 6/16/201025Presented By: Mohamed A. Salem

Reforming the State: The Challenge for Policy The transformation state perspective identifies critical state capacities for managing and regulating rents and for organizing changes in property rights systems. The experience of the high-growth economies suggests that if growth and sustained poverty reduction are the objectives, these capacities have to become the focus of institutional and political reform 6/16/201026Presented By: Mohamed A. Salem

Thank You 6/16/201027Presented By: Mohamed A. Salem