DEVELOPING EFFECTIVE INSTITUTIONS

The major income differential that one observes around the world has a lot to do with differences in the quality of countries‘ institutions and economic policies, as well as on the quality of political leadership. This explains the relative stagnation of most sub-Saharan African countries since 1960.

According to Snowdon and Vane (2005: 637), there is growing evidence linking the quality of institutional development to economic growth; and there is a wide spread acceptance of the idea that ‗good‘ institutions and incentive structures are important preconditions for successful growth and development.

Institutions are defined by North (1990) as the humanly devised constraints that structure political, economic and social interaction. The institutions may be informal (customs, traditions, taboos, conventions, self-imposed codes of conduct involving guilt and shame) and/or formal (laws, contract enforcements, rules, constitutions and property rights).

These institutions provide a structure within which repeated human interaction can take place; they support market transactions; they help to transmit information between economic agents; and they give people the incentives needed to engage in productive activities (Snowdon & Vane

22 2005: 637).

Areas of geography and factor endowments are not the main reasons why some countries progress and grow rapidly, while others stagnate. Countries with poor natural resources, such as Japan, have outgrown many natural resource-abundant economies in sub-Saharan Africa, such as the Democratic Republic of Congo. Thus, an important explanatory variable of economic progress is the political organization and the administrative competence of government (Snowdon & Vane 2005: 636).

Given the importance of this issue, it is vital to focus on such factors as the relationships between economic freedom, democracy, property rights, ethnic heterogeneity, political conflict, the impact of inequality and political instability -- on growth -- as well as on the various measures of social capability.

Abramovitz (1986) has highlighted the importance of social capability, without which countries will not be able to realise their potentials. Social capability refers to the various institutional arrangements that set the framework for the conduct of productive economic activities, and without which market economies cannot function efficiently.

Hence, unsuccessful economies -- in terms of achieving any sustained growth of living standards -- are those that fail to produce a set of enforceable economic rules that promote economic progress. The central issue of economic development is to account for the evolution of political and economic institutions that create an economic environment that induces increasing productivity (Snowdon & Vane 2005: 637).

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2.5 DEMOCRACY, THE QUALITY OF GOVERNANCE AND GROWTH

An important question relating to whether democracy does or does not promote growth needs to be answered. According to Barro (1996), prosperity promotes democracy. Economic freedom promotes prosperity -- and policies that promote economic freedom will also promote democracy. There has never been a liberal democracy (free and regular competitive elections) where there is an absence of economic freedom.

According to Snowdon and Vane (2005: 641), during the 1960s, democracy was often portrayed as a luxury that poor countries could not afford. It was believed that to achieve rapid growth requires tough decisions, while that, in turn, requires firm political leadership that is free from democratic constraints.

Adsera, Boix and Payne (2003) argue that ‗political elites‘ deliberately block the adoption of institutions and policies that would help to eliminate economic backwardness. Superior institutions and technologies are resisted because they may reduce the political power of the elite.

The scope for rent-seeking activities, as well as any attempt to capture economic profits (Parkin 2005: 270) by politicians, who have potential access to huge resources, is greatly increased if the citizens of a country lack information and are denied the opportunity to hold politicians accountable via regular and guaranteed competitive elections.

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sustainable increase in living standards. Furthermore, technological change and innovation are key factors in promoting growth. Thus, the failure in many countries to develop good governance has had serious, and often drastic, economic and political consequences.

The case for democracy rests very much on how regular elections and a free press and media act as important mechanisms that can increase the accountability of politicians.

2.6 CONCLUSION

Sustained growth of total GPD and GDP per capita goes back some 250 years to the Industrial Revolution. Much research has been focused on determining why economic growth has spread unevenly across the world, and has been confined to a small number of countries.

The increase of the capacity of a country to produce can be absorbed by an increase in population, with no upward trend in growth. This is the most common limiting factor to national production. However, countries need to focus on intensive growth, where GDP growth exceeds population growth, thereby allowing for a sustained rise in living standards, as measured by the criterion of real income per capita.

The fundamental causes of economic growth and technological progress help explain why some countries are better able to accumulate factors of production and invest in the production of knowledge. It has been discovered that a successful economy is one with high rates of accumulation of human and physical capital -- together with sustained technological progress.

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The general growth equation or production function helps to clarify this issue.

The production function shows that output is directly influenced by capital stock, labour resources, natural resources, an economy‘s stock of applied knowledge and social capability (non-economic and economic influence). Exogenous factors, such as climate, topography and ecology only play a small role in sustaining economic growth.

The role of institutions proves to be a critical determinant in economic growth. Property rights, the legal system and the quality of governance are all key features. The poor quality of political leadership in sub-Saharan Africa helps explain the relative stagnation of most of its countries.

It was proven that ‗good‘ institutions, formal and/or informal, help economies to grow. Institutions provide a structure within which repeated human interaction can take place. They support market transactions, help to transmit information and give people incentives to engage in productive activities, thereby increasing productivity.

Democracy and the quality of governance both play a significant role in economic growth. Economic freedom promotes prosperity, and policies that promote economic freedom will also promote democracy. The failure in many countries to develop good governance has had serious, often drastic, economic and political consequences. Therefore, it is important to analyse economic freedom in more detail.

The next chapter will focus on economic freedom. The two opposing schools of freedom are discussed. It will show that there is a correlation between economic freedom, political freedom

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and economic growth. The importance of trade and openness is analysed and past findings and relevant research on the topic is discussed.

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CHAPTER 3