Uncertainty is the main factor inhibiting growth and reform in developing economies: uncertainty about the outcome of investment decisions, of the durability of institutions, of the enforcement of contracts, about the accumulation and opportunities given to human capital, and so on.
When uncertainties are measured, they are called risks. It's helpful to divide the kinds of risks to three categories:
* market place or economic risk
* social risk
* political risk.
Political risks arise in the absence of a regulatory regime that enforces rules effectively. Irregular behaviour can happen in both democratic and autocratic countries. During the first Bhutto regime in Pakistan, for example, the government made it hard for firms to obtain licenses without providing shares in their enterprises to the head of state. Needless to say, this discouraged private investment in the country.
Insecure property rights and contract enforcement are two principal source of economic risk. The risks of confiscation, for example, reduce people's incentives to think in the long term.
But reform can't be undertaken by fixing political and economic risks alone. Social risks must be addressed too. Peru's president, for instance, hoped that by distributing land titles he would pull informally held land into the formal sector where they could then support entrepreneurial activity. But, rich oligarchs were able to accumulate great swathes of the newly titled land, which then caused popular resistance to market-based reform in Latin America. This happened because there weren't social institutions in place that could protect these rights.
When inequalities are high the social risks to reform are great because the government can't rely on a steady majority to push through reforms. In many Latin American countries, inequalities are stark so the rich and poor have very different expectations of economic policy. As a result, even many democratic countries in Latin America that enacted economic reforms didn't see full terms because of popular, anti-market uprisings against their reforms. So, investors anticipating this, don't make long term investments unless someone else bears the risk, namely the government, or if the profit opportunities are so short term that they can recoup their investment. Of course, these kinds of opportunities don't lead to long-term development. And this causes a bias against the private sector.
East Asian countries have successfully addressed economic and social risks together. They've put an emphasis on shared growth and social development. In the East Asian experience, as countries became wealthier, income inequality has diminished. They invested heavily in primary education, universal health care, and established rural development banks that not only made loans but trained budding rural entrepreneurs to make wise business decisions.
Regimes that are able to undertake successful social transformation and engage the confidence of their people are exactly the same regimes that are able to undertake ambitious economic reform. By winning the confidence of the people, East Asian countries could create an effective and credible economic bureaucracy that could interact with a private sector that had faith in it.
So, how can we learn from East Asia when we aspire to develop Nepal's economy in a democratic way? My answer is simple - that a credible economic bureaucracy that can maintain a dialogue with the private sector and enable greater entrepreneurial activity is a necessary and decisive condition for growth.
Without such a bureaucracy the government will not be able to play a leading role in bringing about economic development. It is true that a credible bureaucracy isn't a substitute for a fundamental framework that protects private property, contract law and so forth, but it is a crucial complement. Indeed, to have such a framework, one needs the actual apparatus of government in place.
Hilton L Root is a public policy specialist at George Mason University. This comment is excerpted from a talk delivered on 17 July at a seminar on 'Stimulating Economic Growth: the Role of the Private Sector and the Government' organised jointly by USAID, Laxmi Bank and Himalmedia.
Rain and shine - FROM ISSUE #462 (31 JULY 2009 - 06 AUG 2009)
A visible hand - FROM ISSUE #462 (31 JULY 2009 - 06 AUG 2009)
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Too little too late? - FROM ISSUE #462 (31 JULY 2009 - 06 AUG 2009)